A strong dollar, like a strong defense or strong democratic institutions, sounds like a naturally good thing. But it's not. A strong dollar is an unwise goal.
I recently had an e-mail exchange with an extremely distinguished conservative commentator-a familiar name to most-who was worrying that the dollar isn't getting the "respect" it used to.
This is, of course, largely true. But it also embodies an absolutely terrible way of thinking about our economic troubles that really has to stop.
What my interlocutor wanted, as a lot of people (and not only on the right!) seem to want, was a "strong" dollar. A strong dollar, like a strong defense or strong democratic institutions, sounds like just a naturally good thing. It sounds like something every American should want-so long, of course, as they're not some sort of pinko-commie-freak socialist who secretly doesn't want America to succeed.
But they're wrong. A strong dollar is an unwise goal.
Why? Begin by remembering that the word "strong," when applied to currencies, is only a metaphor. The dollar is never literally "strong" like an army or even a cup of coffee is. What it is, is expensive or cheap, like any other thing that is bought and sold. Therefore the dollar needs to be dispassionately evaluated for the costs and benefits of any particular price it bears, not misunderstood as a totem of national vitality.
Remember, for one thing, that a "weak" currency can, paradoxically, confer national advantage. Germany, Japan and China all have undervalued currencies right now-and all three are making out like bandits from this fact. They're laughing, all the way to the bank, much too hard to care whether anyone "respects" their currency. And they're quite happy to let Uncle Sam, eternal sucker of the global trading system, pursue that objective, because it helps them keep their currencies down.
Now that we've gotten the misleading metaphor out of the way, we can start asking the real question: should we want a high or a low dollar?
This question is obfuscated by those who would prefer that the public regard the matter as much too arcane for mere voters to worry about. (Better to let our trusty friends in the financial markets and the Treasury Department take care of it.) But it is really no different than any other question about the price of a thing: whether you want the price to be high or low depends upon whether you're buying or selling. If you're buying, you obviously want the price to be low, and if you're selling, you want it to be high.
Because we, as Americans, both buy and sell things with dollars all the time, the right price of dollars is going to be a compromise between these two needs. If the dollar is too cheap, then imports-starting with oil-will be too expensive. This will lower our living standards and cause inflation. Conversely, if it is too expensive, then imports will be too cheap and our exports will price themselves out of world markets. We will import too much, running up a trade deficit and destroying jobs.
As a result, there's nothing intrinsically good about a "strong" dollar. (Or a weak dollar, for that matter.) What's good for us is having an appropriate price for the dollar. Pace a billion complexities, it is, roughly, the price that balances our trade so that we run neither a deficit nor a surplus.Will the good ol' free market deliver this price for us automatically? No, for two reasons. First, because foreign governments manipulate the dollar values of their currencies, they manipulate the foreign value of ours. Second, because the free market doesn't intrinsically care about time horizons. It can quite easily, in a nation with a bias in favor of short-term consumption, optimize short-term consumption at the expense of long-term economic health. (I explored this latter issue, which is grossly underappreciated, at length in this article.)
Some people confuse a strong dollar internationally with the stability of the dollar's value here at home. These two issues are related, but they're not the same thing. They're related because imports are about 17 percent of our GDP, which means that a lower dollar tends to make that chunk of our economy more expensive. But they're not the same thing, as is clear from the fact that a number of weak-currency nations, like Japan and Germany, have lower inflation rates than we do. Why? Because a lot of other factors get thrown into the mix, like the fact that the cheap capital flows that prop up the dollar lead to inflation in asset prices. If it's domestic inflation you're worried about, it's domestic cost drivers you should be focusing on. And don't forget that an unustainably strong currency (as ours is) is building up inflationary pressures for the day the currency slides.
One can perhaps argue for an artificially cheap dollar so the U.S. can run a trade surplus which will create jobs and start paying back our vast accumulated foreign indebtedness. The problem here is, against whom would we run it? We're such a big economy that a trade surplus big enough to be meaningful for us won't disappear in the rounding errors of the world economy. If such a surplus ever happens, it will be a big factor globally. But the other big economic powers are (unlike us) wise to this game and probably won't allow their markets to be flooded with our goods the way we allow our markets to be flooded with theirs.
So balanced trade is probably the best we can hope for. The price of the dollar isn't the only thing that determines this-tariffs, other trade barriers, and controls on international flows of capital also have their effect-but it's certainly the biggest lever within convenient reach.
There are other problems with pining for a macho dollar. For one thing, one can't demand a strong dollar and simultaneously condemn Chinese currency manipulation. China artificially lowers the yuan-dollar exchange rate, making its currency cheaper in dollars and ours more expensive in yuan, in order to boost its exports and suppress its imports. As many people have argued, this is unfair to American producers. That's why there's a bill pending in Congress with 189 co-sponsors to retaliate against China for doing this.
Trouble is, if you want a strong dollar, then you should be down on your knees thanking Beijing for its currency manipulation, as that is precisely what this manipulation delivers.
Ultimately, it's not the dollar that's the object of anyone's respect. It's the strength of the American economy as a whole. If our economy is sound, respect will flow as a matter of course, regardless of exchange rates. The world is dazzled to some extent by the symbols and totems of power, but in the long run, real power always wins out. That's what we should be caring about.
The author seems to be making a self-contradicting argument. If you truly believe that the price of the dollar is unimportant and should be priced like any other commodity, you would support a freely floating currency in an open market. Manipulating trade policy to influence the price of the dollar certainly isn’t going to give us the “appropriate price for the dollar.” – it is going to give us an artificial price for the dollar based upon the secondary goals of our trade policy.
Briefly stepping away from the abstraction of trade policy, another big advantage of a “strong” dollar for most Americans that the author forgot to mention is that it prevents the value of their savings from being eroded and destroying their prospects of retirement with a decent standard of living. Inflation is a tax on savings. And given the policies of the Fed in recent years, the very last thing in the world anyone should be worried about is an overvalued dollar.
The author has asked that 2 extra paragraphs be added to the original article in response to my comment. My reply follows:
Mr. Fletcher,
I got this revision via email, but I’ll copy it to the website as well for the benefit of anyone else who might want to participate in the discussion.
With all due respect, the same argument still stands even with the benefit of the additional text. The problems you ascribe to the free market can only exist in a market that really isn’t free (currency manipulation to obtain favorable trade terms is neo-mercantilism, not free market currency valuation), and the proposed solution is to artificially price the dollar so that its value aligns with a particular (in this case protectionist) trade policy – hardly an “appropriate” valuation unless your meaning of “appropriate” is “whatever valuation is convenient for American trade policy at the time”.
Furthermore, you reverse cause and effect by blaming domestic asset prices for inflation. Expansionist monetary policy is the very reason why those domestic asset classes end up absorbing excess dollars in the form of price increases. “Inflation is always and everywhere a monetary phenomenon” (but then I’m quite certain you don’t agree with Friedman). The only way to practice currency devaluation while maintaining stable prices is through price controls. Aside from being totalitarian and immoral, we also learned in the 1970’s that price controls really don’t work all that great in practicality either.
The author has made another reply. His comment follows in italics, followed by my reply:
Not what I said. I didn’t “ascribe problems to the free market;” I said the free market wouldn’t solve our problems. These are two different issues.
The first issue is whether the free market, if it exists, will solve this problem. I took no stand on that question.
The second issue is whether, in an international currency environment that isn’t ever likely to be a free market, a free market solution will be effective. It won’t be.
We’re sort of quibbling here, but I think all you’ve done is restated my original contention. What you choose to characterize as a “free market” that is incapable of “solving our problems” is really not a free market in a true sense of the term, so you’re effectively arguing against a strawman.
What your argument now seems to boil down to is: if you can’t beat them, join them! Or more verbosely, that even if free markets were ideal (which you don’t seem to believe to be the case), free market reforms are doomed to failure by the non-participation of others, so we might as well engage in the same type of manipulative behavior as everyone else and see who comes out on the top of the ensuing trade war. I don’t like America’s odds quite as much as you do.
The author had another comment he wished to add – it landed in my junk mail folder so I’ll post it separately. Again, his comment follows in italics followed by my reply:
Friedman’s monetarism, whatever his considerable merits as an economic historian, is a long-dead theory.
It was never really tried in the US, because Paul Volker didn’t buy it. It was tried in the UK, but abandoned in 1983 so Britain could get out of recession.
Theoretically, it has numerous problems, but we can start with these:
1) It assumes no change in underlying scarcities. All the monetary manipulation in the world can’t lower the price of passenger pigeon (or oil!) or raise the price of DRAMs.
2) It assumes the velocity of money is either constant, irrelevant, or having random and thus self-cancelling fluctuations. None of these are true.
3) In practice, the money supply is too hard to measure as soon as one gets away from the monetary base, which isn’t what’s important in a world with many financial instruments that function like money.
With all due respect, it’s hard to take your total dismissal of Friedman all that seriously in light of the fact that most of your economic policy proposals haven’t been considered serious in either the academic or political context since the end of the Free Silver movement and the aftermath of the Smoot-Hawley Act, respectively. All the more so considering that the justifications used by the Greenspan and Bernanke Fed for expansionist monetary policy have had decidedly monetarist underpinnings – for better or worse (the Euro central bank ‘s money supply targets have the residue of monetarist principles as well). You’re correct, of course, to say that orthodox Friedman monetarism “was never really tried” (here, Britain, or anywhere else for that matter), but the same could be said for every academic economic theory – political practicalities make such a thing impossible. Nevertheless, I find Friedman’s monetary explanation for inflation more satisfying than your contention that asset prices will themselves upward and then the money supply follows. It’s a somewhat tangential point anyway. I’d still be curious to hear what manner in which you propose to keep prices stable while simultaneously devaluing a currency.
Another reply from Mr. Fletcher, as we seem to be playing a bit of email tag here :)
No, the free market really isn’t a solution here, because we can’t apply it.
Regardless of whether, in some ideal world, it would work.
I suppose you could say, then, that yours is a utilitarian opposition to free market reforms. Whether principled or utilitarian though, the result is the same.
Mr. Fletcher has sent the following replies. Again, his comments appear in italics followed by my reply:
You’ve conceded my point, then.
I didn’t totally dismiss Friedman. In fact, I complimented his work as an economic historian.
The US only really embraced true free trade in the last 30 years, so no, my ideas are not (de facto!) outdated.
I never gave a comprehensive theory of inflation, which you seem to be trying to attribute to me.
Ian
Mr. Fletcher,
I suppose I have conceded your point in the narrow sense that regardless of whether you believe economic freedom is a good but unachievable moral ideal or you are a committed Marxist, if you’re advocating against economic freedom the result is the same.
I don’t know that I’d call America’s trade for the past 30 years “true free trade”, as much as “relatively freer trade”. I suppose the crux of our disagreement essentially comes down to that distinction. Whereas you want to move America’s policy and the world’s economy toward the trade environment of a sort of neo-mercantilism on the grounds that burgeoning relatively freer trade has somehow failed, I think moving further toward the “free” end on the “relatively freer trade” scale would better serve American policy in light of the damage that trade wars have had in the past, to say nothing of the deeper moral and philosophical aspects involved in centralizing control and impinging on individual rights (I know those are policy consequences that your piece did not touch on, but they nevertheless exist and deserve examination in a complete policy debate).
Perhaps I did unfairly attribute a more comprehensive inflation theory to you than you wish to defend, but your simultaneous calls for devaluing the buck, price stability, and protectionist trade seem on their face to be incongruous (in particular devaluation and price stability which I still contend could only be achieved through price controls achievable only by the most authoritarian state). Perhaps on another day and another article we can delve further into it. I appreciate you taking the time to engage in discussion of your work.
Again, Mr. Flether’s reply in italics followed by mine:
I don’t consider economic freedom to be an absolute. The Founding Fathers–who were protectionists (see Constitution, Art.1, Sec.8)– didn’t either.
America was openly protectionist for most of its history. After WWII, we embraced free trade, but only with the non-communist world and subject to fixed exchange rates and controls on the international movement of capital. The latter restrictions went away progressively after 1975.
Quite right. At the founding of America the works of Smith and Ricardo were brand new and neither had yet successfully challenged the mercantilist orthodoxy of the time at a political and policy level, and then Hamiltonian protectionism dominated American policy even as Britain was embracing free trade in their crumbling and unwieldy empire. As the 3/5ths compromise aptly demonstrates, economic freedom was not the only one which the founders did not consider to be absolute – they were not infallible men.
Freedom that is not absolute is not really “freedom” at all – it is privilege. There are very serious implications even outside of economic outcomes to discarding economic freedom. One need not look further than the modern neo-mercantilist states like China and Japan whose policies you would have the United States adopt to see both the social and economic implications of such thinking.
The very idea of ‘absolute’ freedom is incoherent. Mr. Mulligan really means ‘economic’ freedom. ‘Absolute’ freedom is incompatible with the existence of any sort of human society. Advocates of such freedom are anarchists, not conservatives. The very idea of the “rule of law” or “ordered liberty,” often celebrated by conservatives, has no room for “absolute” freedom.
Gestell,
Of course all freedom is conditional in the sense of crime and punishment. That’s the basis of the law. However, if you are alleged to have a “freedom” that is not absolute and which is conditional not on your behavior, but on the policy whims of elected officials, you do not have a real freedom, you have a revocable privilege. Engaging in legitimate (that is to say, non-fraudulent, non-criminal) commerce should not be a revocable privilege any more than engaging in speech, religion, or self-defense should be revocable privileges.
All governments, at all times, in all places, attach conditions to engaging in commerce. These conditions reduce any ‘absoluteness’ that commerce might possess. Truly free commerce would be completely unregulated. No bonding requirements, no insurance requirements, no taxes, no fees, no licensing, no zoning requirements (A slaughterhouse next door? Why not?)
I’m also fascinated by Mr. Mulligan’s argument that the US, although it started out wrong, with mercantilist leanings, eventually got it right. This means, of course, that conservatives don’t have to defend everything the Founders did, but raises the question–from what point in time does a conservative’s defense begin? And how do you determine it?
Also: you write “at the founding of America the works of Smith and Ricardo were brand new…” I know Ricardo was precocious, but since he wasn’t born until 1772, this puts him out of the running.
Finally: the infamous 3/5 provision in the Constitution. Most of today’s conservatives don’t know what that was about. Well, it was about congressional apportionment. Southerners wanted their slaves to count as population, which would give them an even bigger advantage in the House than they tended to have already, but Federalist opposition held the apportionment ‘weight’ of a slave at 3/5 of a non-slave. Intellectual conservatives used to count this provision among their inventory of examples intended to show the Founders’ misgivings about slavery. God alone knows what Michelle Bachmann would make of it today.
Gestell,
The difference between local regulations, like bonding requirements, insurance requirements, zoning, and licensing, and federal import quotas and tariffs should probably be obvious. The former sets conditions on commerce at a local level without criminalizing commerce itself, which the latter does with the force of a much larger federal apparatus. If I want to start a business mowing lawns and I’m required to carry a $50,000 liability policy, I still have the ability to start a business mowing lawns. If I want to start a business importing widgets from China and we have an import quota on widgets, I do not have the ability to start my business at all. Alternatively, if there is a 80% tariff on Chinese widgets in order to protect the domestic widget market, I can’t start my business under that circumstance either because the tariff destroyed my ability to make a profit selling Chinese widgets – I have no economic incentive to start a business knowing it cannot be profitable (as compared to an outright ban or quota, this is a distinction without a difference). For what it’s worth, I think business is grossly over-regulated at every level, but there simply is no comparison between the petty procedural regulations you mentioned and protectionist trade policy.
I’m also fascinated by Mr. Mulligan’s argument that the US, although it started out wrong, with mercantilist leanings, eventually got it right.
Hardly. We’ve gotten it a little less wrong in some ways and a little more wrong in others. The question in the context of this discussion was whether we should adopt a kind of neo-mercantilist style trade policy more similar to that of our distant past, or move further towards freer trade. Being a “conservative” does not make one an automaton in lockstep with the precise policy prescriptions of one fixed year, month, or day in all of human history. That crap doesn’t work when you try to make anyone who identifies as “conservative” defend slavery or opposing women’s suffrage, and it doesn’t work here. Considering the wildly divergent policy proposals of the founders and early American leaders in addressing issues on which they were in wider ideological agreement, there’s almost no policy that couldn’t be considered “conservative”.
Finally: the infamous 3/5 provision in the Constitution… Well, it was about congressional apportionment.
I don’t think that fact was lost on anyone here. It was still bad policy that enshrined slavery into the constitution and rejected the fundamental rights of certain human beings – which was the important point in the context of my argument (in fact, the vast majority of your commentary is entirely tangential to the point I was trying to get across). The founders were brilliant men, the government they created reflected that brilliance, but they were not deities. That they supported a particular policy doesn’t necessarily make it a good policy. You’ve been confused about this concept in previous discussions we have had as well. As I have said before in one such discussion: the ideas of the founders aren’t good because they came from the founders – they’re just good ideas. When you separate the ideas from the vehicle by which they were advanced, you are free to reject bad ideas by the vehicle. I suppose that probably comes off sounding very counter intuitive given the penchant for liberals to deify and lionize their political leaders.
Re: Ricardo, the Constitution was ratified in 1788, the Bill of Rights was ratified in 1791, and Ricardo began publishing papers shortly after the turn of the century. 2 presidential administrations deep into its life, I think you could safely say the country was still in its founding, and there was almost certainly awareness of his work at the level of academia and government. American policy at the time opted for precisely the opposite approach. We rejected Smith, whose work inspired Ricardo’s, on trade policy as well.