Thursday, December 6, 2007

The Dollar is Falling....Big Deal

Tyler Cowen, author of Discover Your Inner Economist: Use Incentives to Fall in Love, Survive Your Next Meeting, and Motivate Your Dentist, wrote a great piece in the New York Times a few days ago entitled, "The Dollar is Falling, and That's Good," about the current hullabaloo regarding the falling value of the greenback. Its been in the news a ton lately and financial sages like Buffett have been warning about the precarious position a devalued dollar puts us in with countries like China holding so much of our debt in their hands. I admit, I've had mixed feelings about the real impact of a falling dollar wondering often, "Is this really something I need to be worrying about?" Cowen puts things in perspective:

ANXIETY about the dollar continues to spread. The falling greenback is often seen as a sign of an impending recession or the fall of the United States from global leadership. A low dollar simply looks bad. We are, after all, used to judging ourselves against others — comparing our salaries with the earnings of our peers, and our homes with those of our neighbors. We’re used to thinking it is a big advantage to stand at the top of a numerical list.

But when it comes to currencies, a higher value neither brings national success nor predicts future prosperity. The measure of a nation’s wealth is the goods and services it produces, not the relative standing of its currency. Take a look at 1985-88, when the dollar lost more ground than in the last few years. Those were good times, and the next decade was largely prosperous as well.

Today’s lower value for the dollar reflects the success of other regions. Europe has shown it can make the European Union and its unified currency work, and thus the euro has become stronger. The Canadian union appears increasingly stable, and that means a higher value for the Canadian dollar. Over all, these geopolitical developments are good for America even if the dollar becomes weaker in relative terms.

As to the concern that China could lay the wood to America by dumping the dollar:

Another worry is that a falling dollar puts the United States at the mercy of China. Dr. Brad Setser, a currency analyst at RGE Monitor, estimates that the Chinese hold about $1.2 trillion in dollar-denominated assets. China is likely to slowly diversify into other currencies, but Chinese leaders have no interest in encouraging a run on the dollar or a fire sale of dollar-denominated assets. China is in a more vulnerable position than the United States, if only because China is a poorer country and has underdeveloped capital markets.

Cowen concludes that all of the people claiming the sky is falling need to relax:

Still, it would be naïve to argue that a weak or falling dollar can never hurt the United States. Extreme volatility can increase general anxiety and discourage economic commitments. If the dollar went into a true free fall, it would damage the reputation of the United States as a desirable place for foreigners to invest. That would hurt; but on the other hand a low dollar would mean bargains for foreigners, thereby attracting investment and limiting the potential negative fallout from a dollar collapse.

SO far the Federal Reserve and the Bush administration have shown little concern over the falling dollar. This isn’t because of neglect or lack of interest; trillions of dollars worth of currency are traded every day, so policy makers have only a limited ability to push around long-term exchange rates, even if they wanted to do so.

When it comes to market prices, people can always find reason to be unhappy. In the eurozone, for example, it is a common complaint that the euro is too strong and therefore it is too difficult for Europeans to export goods and services.

In the case of the dollar, we need to stop thinking of its value as a marker of economic success. The American economy has its problems, but so far the low value of the dollar has proved more a benefit than a cost.

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