Is a Strong Dollar a Good Thing or a Bad Thing?

Source: Forbes

You are probably way ahead of me on this, but I’ll say it anyway: It depends.

A rising or declining dollar both affect different groups in the economy differently. A rising dollar relative to the currencies of our trading partners generally makes our imports cheaper to our consumers and our exports more expensive to foreign buyers. That translates loosely into being good for consumers consuming imports and bad for exporters selling abroad. Whether that is a net positive or a net negative depends in part on the state of the economy. It’s probably a net negative if the economy has a lot of slack in it with low capacity utilization and high unemployment. Under those circumstances the trade effects won’t help the economy come out of recession and may make a recession worse. In saying that, I’m focusing on aggregate demand in the economy, which is lowered if exports fall relative to imports.

In the above circumstance, consumers of imports will still benefit as consumers, but some of those consumers may have their employment in export related industries compromised. If so, for them, the harm will be more concentrated than the benefits. If the dollar is falling, employment in export related industries will likely benefit, but the higher domestic prices likely associated with export products (because of higher foreign demand) will reduce that benefit to some degree, and the higher prices for imports will reduce it even more.

Net, net, a stronger dollar is likely a headwind in a weak economy.

In a stronger, fully-employed economy, a rising dollar will still act as a headwind in that it reduces total effective demand, but the benefits to consumers in particular and the population generally will likely more than offset that negative. A stronger dollar reduces the dollar price of imports and makes them more affordable to domestic consumers. Some industries that compete with those imports will be hurt by the greater competition, but in a robust, fully-employed economy their adjustments shouldn’t be too painful.

From the broad macro perspective, a stronger dollar benefits the domestic population by improving their terms of trade with the outside world. By that, economists mean we get more imports (the benefits of trade) per dollar of exports (the cost of trade). Much bad trade policy is based on the confusion over which is the cost of trade and which is the benefit. That is exacerbated because our legislators are likely to hear more from exporters than consumers because the impact on the former are more concentrated and noticeable that the impact on the latter.

Net, net, a stronger dollar raises a country’s standard of living by improving its terms of trade, which more than offsets the negative head-wind effect in a healthy vibrant economy.

This brings us to the question of what is the current state of our economy? Strong enough to benefit from a strong and rising dollar? Or still too weak to give up the aggregate demand benefits of a weak dollar? It’s obviously stronger than it has been, but it still isn’t strong. Normally, the answer to the above question is easy if the dollar rises because of greater competitiveness and an improving international trade balance. But a major reason for the strong dollar recently is the falling Euro, Japanese yen, Australian and Canadian dollars, etc. Weaker foreign currencies are the mirror image of a stronger dollar and shouldn’t pose a problem. However, to a great extent policymakers abroad, especially in the Euro-zone, are using currency depreciation as a policy tool to stimulate their economies. To that extent, one might argue that the dollar is rising farther and faster than the fundamentals justify, and the impact on our aggregate demand may more than offset the improvement in our standard of living via the improved terms of trade.

The recent decline in oil prices was a good thing, but it became disruptive when it was helped along by non-market forces. The dollar is in a similar situation. If I were the economic czar of the U.S., I wouldn’t make a big deal out of it publicly for fear of stoking protectionist sentiment and the mindset of a currency war. But I would whisper in a few select foreign ears that enough is enough for now.