Subscribe to BrookesNews’ Bulletin `

Why a "cheap dollar" would not save the US economy

Gerard Jackson

Monday 5 April 2010

According to Nobel laureate Joseph Stiglitz: "Right now, it’s not in the interest of the U.S. to have a strong dollar. We want a weak dollar and we want exports." During the Great Depression this policy of encouraging weak currencies was called "exchange dumping", a devious means to eliminate your competitors' advantage. What is not generally understood is that depreciation is the obverse of inflation. In other words, to depreciate the currency one must first inflate it. The logical consequences of such a policy is that it could result in "competitive depreciations".

If depreciation is the road to economic prosperity then it follows that printing money is what really raises the standard of living: a thoroughly ridiculous proposition. A genuine depreciation should not be a matter of policy but the result of a misguided inflationary policy. This happens where a loose monetary regime results in an overvalued currency thereby reducing the flow of exports while artificially stimulating imports. A depreciation in these circumstances is a process of restoring equilibrium, not a means of gaining a trading advantage.

It's truly outrageous that an economist of the standing of Stiglitz could possibly suggest that debasing the currency is the way to improve Americans' economic wellbeing. Many, particularly exporters and domestic producers squeezed by imports, would welcome a devaluation on the grounds that it would promote economic growth. But this belief is based on a mercantilist fallacy.

Now whenever there is a rise in the US dollar some commentators and producers lament the effect that this will have on exports and the balance of payments. Their logic is very straightforward: Since a falling dollar is alleged to stimulate growth by increasing the demand for exports a rising dollar must therefore choke it off. That a depreciating dollar would tend to expand exports is perfectly true — the rest is fantasy. A quick look at their psychedelic economics immediately reveals no real understanding of the nature of economic growth.

Assuming that the dollar were to fall, this would reduce the cost of American tradables in terms of other currencies. This means that living standards will be lower than they would otherwise be because the terms of trade have now become adverse. In plain English, Americans must export more for the same quantity of imports. This is like someone working more and more hours for the same amount of pay. No one in his right mind would claim that this labourer's living standard is rising simply because he is working longer hours just to maintain the same income, but this is what is really being said about the consequences of a falling dollar.

Living standards drop not just because imports become more expensive but because capital goods (the material means of production) are scarce. To satisfy other countries growing demand for US goods as the result of a depreciating dollar export industries would have to expand output. This means, unless there is a considerable amount of idle capacity, that land, labour and capital must be withdrawn from other lines of production thus curtailing their output, or at least expansion. (See William H. Hutt's The Theory of Idle Resources, LibertyPress 1977.)

Some observers, particularly Keynesians, would argue that an increase in the demand for exports also raises the demand for labour and thus increases wage rates. This is not strictly true. Where there is unemployment any increase in the demand for labour in these circumstances is entirely due to the depreciating currency cutting real wage rates. (In the 1930s this was called exporting your unemployment). Where there is no unemployment real wages rates are still cut while the composition of the demand for labour changes.

It should now be obvious that an increase in exports due to a depreciating currency would have to take place at the expense of domestic consumption. It baffles me how those bright sparks who make their money by selling economic advice can describe this situation as healthy let alone one of economic growth.

Japan used to be touted as an excellent example of export led growth. But this was never the case — and it certainly isn't the case for China. For nearly 40 years Japan's terms of trade for its manufactures declined, meaning that it had to export more and more for the same quantity of imports. But the fundament difference between the Japanese experience and one brought about by a falling currency is that Japan's change in the terms of trade for its manufactures was entirely due to increasing productivity and not a depreciating currency. This is why Japanese living standards rose significantly even as it developed an 'adverse' terms of trade.

I never tire of pointing out that savings fuel an economy and entrepreneurship drives it. Japan had an extremely high saving rate which enormously increased its productive capacity while entrepreneurs did the rest, despite powerful government intervention — which includes extreme Keynesian policies — from which the country is still suffering.

To argue that a boom in American exports induced by a devaluation would generate economic growth is to imply that savings and investment are unrelated. Do the advocates of a depreciating dollar think that by merely increasing exports the US would enjoy rise in per capita investment, especially in view of Obama's crippling fiscal policies? Have these people ever given any serious thought to the actual nature of economic growth?

Gerard Jackson is Brookesnews' economics editor

Subscribe to BrookesNews Bulletin