A weaker dollar doesn’t mean you’re earning less

By Felix Salmon
May 5, 2011
Matt Yglesias says that there's no difference between currency depreciation and real wage cuts:

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Matt Yglesias says that there’s no difference between currency depreciation and real wage cuts:

Your wages are denominated in dollars, so if the value of a dollar declines your real wages decline. Currency depreciation isn’t an alternative to real wage cuts, it’s a mechanism by which real wages can be cut.

This isn’t really true, unless you’re being paid in dollars and living abroad. On a trade-weighted basis, the dollar has declined by about 11% in the past 10 months or so. Does that mean that my real wages have fallen by 11% in less than a year? Should responsible employers wanting to keep their employees’ wages constant on a real basis have given them all an 11% pay hike in dollar terms? Of course not.

In order to convert nominal dollars into real dollars, you use inflation, not any change in the value of the dollar. When the dollar depreciates, sometimes that shows up in inflation — and sometimes it doesn’t. After all, the dollar has been depreciating pretty steadily for a decade now, without any sign of inflation picking up.

What a cheaper dollar does do is make US workers cheaper relative to their foreign competitors. That doesn’t mean those workers are taking a real wage cut, any more than productivity increases are real wage cuts. But it can still improve the quality of life here in the US. The Treasury secretary loves to intone that a strong dollar is in the national interest. And maybe in some senses it is. But in other senses, a weak dollar can be very useful indeed for boosting employment and growth.


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Actually there is a connection between dollar decline and wage cuts, it is not just that simple (people like Milton Friedman have pointed out that currency decline is like, but much faster and easier than wages cuts – see Spain, Portugual, Ireland, uh, the entire EU economic periphery for illustrative examples of the alternative). Currency decline shows up in inflation as a rise in the cost of those consumables that are imported – japanese cameras, german cars, oil – and not in hair cuts, management consulting, dental work, etc. Importable consumables are a much smaller component of a continent-scale economy like the US. And recent-historically, in fact, importers have been willing to swallow some of the rising costs simply to preserve market share in a continent-sized consumer economy.

Posted by seanmatthews | Report as abusive

So after the last post, I followed the link, and Mat’s post is much more sensible than you sort of imply. And he also makes the important point that currency decline does not not inflate real (dollar denominated) debt, unlike wage cuts.

Methinks your post was a bit hasty.

Posted by seanmatthews | Report as abusive

Imports are 15% of GDP. Therefore, a 11% decline in the value of a dollar is roughly equivalent to 1.6% inflation, all else being equal. But, of course, “all else” is not being equal, because there are lots of other things that fluctuate: trade balance may shift, importers may be willing to swallow some costs, etc. For example, the 1.6% increase assumes that growth in exports is fully transmitted to workers. Since cheaper dollar means that you and I have to spend more on importables, it also means that we have to spend less on domestic goods & services. In the ideal world, this effect is compensated, because higher exports mean that workers in exporting industries get raises. In the real world, higher exports end up sitting idle in bank accounts and brokerage accounts of the top 5%, therefore the aggregate demand for domestic goods & services falls, therefore domestic prices fall, therefore overall inflation rises by less than 1.6%.

Posted by Nameless | Report as abusive

Er… yes it does.

Don’t just look at imports… look at exports too. Lots of Corn I’d like to buy at a dirt cheap price in my cornflakes are now being fed to cattle because people from away are eating more meat.

Americans are losing their spending power… you just don’t see it as much because you don’t often drive a car and your already spent a massive amount on food.

Posted by y2kurtus | Report as abusive

I think the truth is somewhere in the middle between you and Iglesias. Pay has definitely not declined 11 percent. An embarrassingly high percentage of Americans don’t even have passports. That said, the decline of the dollar is definitely making us somewhat poorer.

First, inflation has not been muted across the last decade at all. Stripping out “volatile food and energy prices” is not appropriate when they move steadily upward. Smoothing out with something like a two-year average of food and energy prices would be give a much truer view of inflation.

Second, most of us reading this blog are, to varying extents, ‘global people.’ We will take the overseas trip from time to time, and perhaps do so often depending on our interests or line of work. If we are able to travel overseas less often because it gets more expensive, aren’t we poorer? Absolutely. It may be true that Japanese and Chinese workers are both paid in a way that is commensurate with the costs in those countries, but a typical Japanese person can live very well in most of China while the reverse is not true. Is the Japanese person richer? If they ever have a meal together (anywhere in the world) and it is time to pick up the tab, it will be plain that the average Japanese person is much richer.

Posted by DanHess | Report as abusive

I think DanHess makes some good points. From my perspective I think that the most profound effects of dollar depreciation show up in trade and in going abroad. Given that something like 80%+ of US trade is with China and Canada – one currency officially pegged to the USD and other that mirrors it closely – I don’t think there will be much of a spike there. Also, I think the number is 73% of Americans don’t have a passport, ie have never and probably will never step foot out of America, so the second point isn’t really addressed except by people who can afford it. With that in mind, it’s hard to say the average American is really all that effected by the USD decline… not yet at least.

Posted by CDN_Rebel | Report as abusive

Your article makes sense if you are looking only at wages in isolation, but it falls down when you look at the big picture of “well being”. In 1969, a year at a private university was $1640.00. A nice new car was $2000.00. The house I grew up in cost $60,000.00. Now, the university is $40,000.00, a nice new car is $40,000.00, and that same house recently sold for over $600,000.00. My father put all 8 of his children through college and my mother, like most mothers back then did not feel obligated to work. I am in exactly the same profession as my dad, and my wife works very hard running her business, yet we have struggled severely to put our 3 children through the same college! Your article did not convince me that a weak dollar is not the same as a wage cut. Not only does the same money buy less, but the tax man takes more since you are now making more (cheaper) dollars and are “rich”.

Posted by zotdoc | Report as abusive

@zotdoc – You’ve made the mistake of confusing nominal dollars for real dollars. Sure, the headline prices of all of those goods have appreciated. But so have nominal wages.

It’s not enough to look at the price of a good. You have to look at the amount of purchasing power it consumes. To take a few of your examples – the nominal prices of homes have increased dramatically, but for the most part the real prices have paced inflation, so housing consumes about the same portion of income over time. The real price of vehicles, in many cases, has fallen.

College is an outlier – it’s real cost continues to rise, so it consumes an ever larger share of income. But unless you’re attending university overseas, that’s really beside Felix’s point. The rising cost of college domestically isn’t due to a weak dollar, because your college education is purchased in dollars. It’s driven by other forces.

I would also note that a lot of other posters complain that a weakening dollar is a real decline in their purchasing power, because they’re active members of a global community. But that’s the point! If a weakening dollars makes imports more expensive, that goes a long way to redressing our trade deficit. Or else why have we spent so much time complaining about the distortionary effects of the Chinese currency peg?

Posted by strawman | Report as abusive

Seems to me you are both correct…

A falling dollar will increase the cost of imported goods, but that is only a small piece of GDP. Most of our economy is domestic and unaffected by exchange rates. Notable exceptions are energy (largely imported) and food (enjoys a strong export market).

If we’re worried about the rising food prices, we can stop turning corn into ethanol.

Posted by TFF | Report as abusive