Why a weaker dollar isn't boosting the economy.

Why a weaker dollar isn't boosting the economy.

Why a weaker dollar isn't boosting the economy.

Moneybox
Commentary about business and finance.
May 14 2003 6:15 PM

Less Bang for a Buck

Why a weaker dollar isn't boosting the economy.

In recent months, the dollar has declined precipitously against other currencies. So far this year, the euro has appreciated about 30 percent against the dollar, while the Japanese yen has risen 12 percent.

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The slide hasn't elicited much concern from the administration—or from its critics. It is one of the unwritten rules of the global markets that the U.S. government must always be on the record as supporting a strong U.S. dollar—and not just for reasons of national esteem. Any nation that depends heavily upon imports—oil, circuit boards, sneakers—needs a strong currency to maintain its standard of living.

Still, a weak dollar can have salutary effects on a slow-growing economy. Yesterday, the Commerce Department reported that the March trade deficit was $43.5 billion, the second-largest monthly figure in history. Since we notched a small surplus in the trade of services, the entire deficit can be ascribed to our tendency to import far more goods than we export. When the dollar weakens, however, goods made in the United States become cheaper for foreign buyers, and goods made by foreigners become more expensive to America's vast consumer market. In theory, a declining dollar should stimulate greater demand for U.S.-based products and services, thus giving the economy a jolt and lowering the trade deficit. Which may explain why Treasury Secretary John Snow, while dutifully repeating the strong-dollar mantra, has subtly sent signals that the dollar's currently diminished status is acceptable.

But there's reason to think today's weakened dollar won't put much of a dent in the trade deficit. For while the U.S. currency has declined against the euro and the yen, it hasn't fallen against the currency of the nation that accounts for the largest—and most rapidly growing—slug of our trade deficit, China. In March, the United States ran a $6 billion trade deficit with the euro zone and a $7.67 billion trade deficit with China.

The euro, the yen, the dollar, and the British pound float freely in value against one another. But many currencies in the world are pegged—either directly, or indirectly, by law, policy, or custom—to the dollar. Ecuador in 2000 simply adopted the greenback as its currency. Other nations—virtually the entire Caribbean, African countries such as Djibouti and Nigeria, Iran, and Iraq—directly peg the value of their national currency to the dollar. And many others maintain more or less formal policies of having their domestic currencies move in lockstep with the Yankee dollar, give or take a few percentage points. (For a comprehensive listing of currencies and their relationships to the dollar and other currencies, click here.) "By tying their monetary policies to ours, other nations end up with all the credibility of the Federal Reserve Board," said David Gilmore, partner at Foreign Exchange Analytics and the rare currency expert with a knack for plain speaking.

Since 1994, China has effectively linked its currency, the yuan, to the dollar. The government essentially guarantees that it will buy the local currency for dollars within a fairly narrow band. By keeping the yuan tightly aligned with the dollar, China perpetuates the cost advantage it has over the United States as a manufacturing center. When the dollar weakens against the euro and the yen, the yuan weakens by roughly the same proportion. As a result, U.S. consumers won't find Chinese-produced goods to be any more expensive today than they were a year ago. Perhaps more significantly, a U.S.-produced dishwasher won't seem any cheaper to European or Japanese buyers than similar products made in China.

One of the good things about being a superpower is that countries the world over want to tie their economic fortunes to yours. But with the fortunes of the yuan, and of many other currencies, explicitly linked to the dollar, the United States won't get quite as much bang from its weakened buck.