November 08, 2004

Dollar down

So the dollar's falling, I see. Theoretically speaking, a falling dollar shouldn't be "bad" or "good" in any meaningful sense. But that's theoretically speaking, and the reality is quite different. Some Bush supporters will inevitable chatter on about how a falling dollar will help correct the trade deficit and boost American manufacturers because it raises the price of imports and lowers the price of exports. But here are three reasons why that may not happen, and why we may be in a heapload of trouble:

1. US manufacturing industries don't have a lot of unused capacity waiting to be filled. So a dollar decline doesn't mean they would be able to export a whole lot more stuff; rather, they'd find that the stuff they did export would become a whole lot cheaper. Profits would plummet. Bad.

2. A lot of stuff we import simply can't be made in the US, including a lot of high tech equipment, key components, and capital goods. Prices rise. Bad.

3. Oftentimes, as Japan did during the dollar decline in the 1980s, foreign competitors will simply lower the prices to remain competitive, and then make up for the profit loss by taking advantage of the exchange rate. More bad!

The doomsday scenario, of course, is that a devalued dollar leads to higher import prices, which leads to inflation, which in turn causes the Fed to raise interest rates, which slows the economy but also attracts foreign investors to U.S. treasuries, which in turn pushes UP the value of the dollar (since you need dollars to buy those treasuries), thereby exacerbating the trade deficit. That's a raunchy downward spiral, to go on ad infinitum until who knows what.

Also, the problem with American manufacturing is not really weak domestic demand, as our favorite marxists over at EPI once explained. This doesn't really relate to the above, but it's another myth that gets bandied about, most recently by the Congressional Budget Office. Tsk, tsk.
-- Brad Plumer 1:28 PM || ||