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“A mighty economy with a strong dollar and a lot of purchasing power for consumers is the stuff of politicians. A strong dollar represents economic strength and stability. A strong dollar makes Americans proud. A strong dollar just sounds right. Why shouldn’t the world’s largest economy with the most powerful military force in history have a strong currency? While it may sound right, or be intuitively appealing, the idea of a strong currency does not necessarily represent sound economic policy and may not be in the best interest of a country.
It may be the terms themselves that produce the misguided judgments. Strong is preferred over weak in most situations. It is better to have a strong heart than a weak one. When building a tall structure, strong steel beams would be preferred over weak ones. A strong bond between a parent and a child is generally perceived as being better than a weak relationship. So, it seems correct that a country should also have a strong currency. Some have proposed changing the terminology from strong and weak to “import” and “export” in order to avoid a natural preference. With the US dollar (USD), it would be called an export dollar when the USD is weak and an import dollar when it is strong. When the dollar is weak American goods become cheaper for foreign buyers and when the dollar is strong, American exports are more expensive. Changing the way we refer to a currency might change the view in which a strong currency is perceived as better.
Putting aside the question of the merits of a strong dollar for now, it is clear that a dollar doesn’t buy what it did in the past. The purchasing power of the US dollar has eroded for many years. While the relative economic strength of the American economy relative to the rest of the world can be debated, especially as much of the world has made significant economic gains since the end of the War, the driving force in the decline of the purchasing power of the dollar is inflation. One would have to consider wage levels to get a more accurate view. In 1948 the minimum wage was 40 cents an hour. The current federal minimum wage is $7.25 per hour, with some states having an even higher minimum wage requirement. While the cost of a loaf of bread may have been around 14 cents in 1948, with a 40 cent minimum wage, it took 21 minutes of working to buy one. At the current federal minimum wage, 21 minutes of work earns $2.54. Inflation eroding the value of a currency is not unique to the United States. Even small levels of inflation over time greatly erode the purchasing power of a currency. As long as wage levels keep up with inflation, the situation is not too problematic.
Putting purchasing power aside, the strength of the US dollar can be compared to other currencies using the US Dollar Index, or DXY. Created in 1973 by J.P. Morgan, the index compares the value of the USD to a basket of weighted currencies which include the Japanese yen, the British pound, the Canadian dollar, the Swiss franc, the Swedish krona, and the euro (the index was altered when the euro was introduced). The euro is very heavily weighted in the index representing 57.6 percent of the composite. By contrast, the Canadian dollar has a weight of just 9.1 percent of the index value. When the DXY was created in 1973 it was set at a baseline of 100. Since 1973 the index has risen and fallen (the high being in 1985 at 164.72) and by Election Day in the United States, November 6, 2012, it stood at 80.64. The USD has experienced periods of strength and weakness. From 1980 to 1985, for example, the USD rose significantly in value (even though the US was experiencing an increasing deficit in trade) causing leaders from the Group of Five (Germany, Great Britain, France, Japan, and the US) to hold an emergency meeting in New York to discuss the matter. The result of this meeting (held at the Plaza Hotel) led to the “Plaza Accord” whereby the countries would sell dollars in order to bring down the value of the USD. The agreement worked and the USD decreased in value to a point where the process was stopped and the dollar eventually allowed to once again rise.
In recent years the USD has seen a weakening, with the exception of the financial crisis in which investors flocked to the dollar as a safe harbor. A number of factors can explain the weakening, from government spending in the US to the strengthening of some economies due to global demand for their natural resources. The weakness in the dollar could be attributed to the efforts of quantitative easing (QE) in which the Federal Reserve through a series of rounds injected money into the economic system, in essence, printing money. The rising supply of a currency, all other things being equal, will reduce its value relative to other currencies. However, Japan and other developed countries have also had quantitative easing programs. In the case of Japan especially, the program was not effective in curbing the rising value of the Japanese yen.
According to an article in The Economist, many countries no longer see a strong currency as a positive and necessary aspect of economic development. Especially after the financial crisis which began in 2008 countries sought to have weak currencies in order to increase exports and create jobs. When in the past a strong or at least stable currency was seen as desirable, that view is not shared by all today. When a country’s currency declines in value it makes its exports cheaper in the global market.
Perhaps increasing the trend towards a weak currency is the ability of countries to manipulate their currency values. In terms of manipulating a currency it is easier to devalue than revalue one. To revalue or increase the value of a currency, that currency must be purchased using foreign reserves, which for many countries is increasingly more difficult. To devalue a currency all that is needed is to increase the supply of the currency, essentially printing more. In recent years that process has not always proved to be as effective as in the past.
Interest rates also play a part in determining currency values. According to the International Fisher Effect a country’s currency value is inversely related to nominal interest rates. In other words, if nominal interest rates are rising in Country A relative to Country B, Country A’s currency will be decreasing in value relative to Country B. Interest rates are driven, in part, by inflation. Again, that relationship does not seem to be, at least in the short-term, as predictable as in the past. As interest rates in much of the developed world have fallen and inflation fears replaced by the fear of deflation, increasing interest rates can attract more capital from abroad, thus increasing demand for the currency.
A weakening dollar has a number of effects for Americans, both positive and negative. On the negative side, a weakening dollar makes imported goods more expensive for consumers. In addition, imported component parts and commodities used in producing goods in the United States rise in price. The price of oil and its derivatives such as gasoline also rise. While oil is for the most part priced globally in dollars, it is assumed that oil producers attempt to manipulate the price in order to make up for their declining revenue from a weakening dollar. In addition to imported goods, international travel for Americans becomes more expensive, both for leisure as well as for business purposes.
A weak dollar does have a number of advantages as well. As previously mentioned, a weak currency can help a country increase exports as those goods become less expensive to foreigners. Increased exports can then produce more jobs as export demand rises. However, in the case of the United States at least, the theory of a devalued currency promoting export growth has not been very robust. Even if export growth is not as strong as predicted by devaluation, American firms report higher profits from foreign operations as their foreign earnings are translated into more dollars. In addition, when the dollar weakens foreign investors may see greater opportunities in the US as these investments too become more financially attractive.
To resolve the question of which is better for the United States, a strong or weak dollar, some have proposed that one only needs to look at modern history for an answer. For example, Charles Kadlec, writing in Forbes says, if one compares the dollar policies of the last six presidents, a clear pattern emerges. Under Presidents Reagan and Clinton a strong dollar policy was followed resulting in strong economic growth. Under Presidents Carter, Bush 41, Bush 43, and Obama, a weak dollar policy was followed resulting in less stable economic growth. The validity of this means of making an assessment could be challenged as overly simplistic. Factors driving economic growth are complex, and even factors driving the strength of the dollar are complex, however, a decision on policy which favors a strong or weak dollar is important to the United States and the rest of the world.”
“1 What is the effect of a strong or weak dollar for the rest of the world?
2 Some countries, many being developing countries, peg their currency to the US dollar. What effect does a rapid appreciation or devaluation of the dollar have on those countries?
3 If you were an exporter from an emerging country to the United States would you prefer a strong or weak dollar? Explain. “