Sunday, February 8, 2009

Benefits of a Strong Dollar

Over the past year, the dollar has risen sharply against Europe's currencies and the Canadian dollar. Although it has weakened against the Japanese yen, that has had less impact because the U.S., comparatively speaking, doesn't import as much from Japan than it did, say, 30 years ago. Many and perhaps most countries sliding into recession would like to weaken their currencies, because then they can try to export their way out of their problems. The U.S. cannot, for practical purposes, weaken the dollar. The Fed has already lowered short term interest rates to an effective rate of zero. And it's been printing truckloads of money as part of the financial system bailout, without any obvious impact on the value of the dollar.

The dollar is strong because of market forces. Other nations' economies are fading faster than the U.S. economy (if you would believe it). Capital is fleeing to the dollar, because it remains the safest haven available. Even though we can't export our way out of our problems, we receive countervailing benefits from a strong dollar.

Oil prices, which are denominated in dollars, have fallen as the dollar has risen. This price drop directly boosts consumer incomes, at the expense, in some cases, of people who harbor ill-will toward the United States. Better that they should provide a stimulus now than the U.S. taxpayer.

Federal Reserve monetary policy is made much easier. Ordinarily, lowering interest rates weakens a nation's currency while exacerbating inflation, and encourages capital flight. But the strong dollar has done much to stop the acceleration of inflation that, as recently as six months ago, was a major potential complication to the Fed's strategy. Chairman Ben Bernanke is a very lucky central banker. If we are going to have a central bank, we want a lucky one.

The federal deficit is easier to finance with a strong dollar. Much, if not most, of the Obama administration stimulus and bank bailout packages will have to be financed with money from overseas. A strong dollar provides reassurance to foreign investors. The U.S. should be able borrow at lower interest rates.

International commerce operates more smoothly with a strong dollar. The dollar is the world's reserve currency and is used more than any other currency for international trade. Commerce benefits from a strong, stable currency. One need only look back at pre-Civil War America for times when there was no permanent national paper currency. There was tremendous demand for a medium of exchange, however, and a variety of things served as currency, including tobacco, deer and other animal skins (whence the term "buck"), pieces of Spanish coins (the origin of "quarter," which resulted when a Spanish doubloon was cut into four equal sized pieces), and promissory notes issued by state banks, private banks and even individuals. It's not an accident that the U.S. experienced its greatest industrial growth after the permanent adoption of federally issued paper currency. International commerce, which must remain vigorous in order to facilitate a recovery, would struggle if there were no readily accepted transnational currency.

However, before we congratulate ourselves on the might of the dollar, let's remember that our current good fortune results from market forces. The past two years have abundantly demonstrated the market is tempestuous even on good days, and what it giveth it can easily taketh away. With the government about to borrow a trillion or more, and the Fed printing another trillion or more, the market could turn tail and flee the dollar in a New York minute. The music you hear in the background isn't "Columbia, the Gem of the Ocean." It's Carly Simon's "You're So Vain."

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