Why the world needs a weaker dollar

By Guest Contributor
October 8, 2010

IRAN-CURRENCY/RATE/Kathleen Brooks is research director at forex.com. The opinions expressed are her own.

Ever since the last Federal Reserve meeting when the prospect of further policy stimulus for the US gripped the market, dollar weakness has been the dominant theme in FX. The Fed action is considered in some quarters as a backdoor form of currency devaluation, and there has been talk of a global “currency war” as a result.

But is a weak dollar really that bad for the global economy? Those countries who argue yes tend to concentrate on self-preservation since a weak dollar makes higher yielding economies’ exports less competitive. Since everyone wants to be able to sell to the US – the biggest single consumer market in the world – when the dollar moves in any significant direction the world takes notice.

Already Brazil and South Korea, whose currencies have risen strongly this year, have embarked on capital constraints to try and dissuade “hot money flows”, amid fears that a strong currency will derail economic growth. Chinese premier Wen Jiabao even went so far to say that a rapid strengthening of the renminbi against the dollar would be a “disaster for the world.”

Is it really as dramatic as the Chinese premier seems to think? There is a strong case for a weaker dollar and it all has to do with the spectre of deflation that hangs over the developed world. The current average inflation rate amongst the G10 economies is on the low side at 1.5 per cent. If you strip out Australia and the UK – both economies with high levels of inflation- the rate drops to a meagre 1.2 per cent. Combined with a weak growth outlook, especially for western economies facing fiscal austerity, this keeps the threat of deflation alive and well.

The problem with deflation is that most economies are unprepared for it. It can depress demand as consumers delay purchasing in the hope of lower prices in the future, this, in turn, causes unemployment. It also depresses asset values, which weighs on investor confidence creating a negative spiral of low or anaemic growth that can last for a long time (read Japan’s lost decade).

A weaker dollar is a crude cure for deflation. Since commodity prices from food stuffs to oil and industrial metals are all priced in dollars, a weak greenback means commodity prices go higher. This puts upward pressure on inflation and, more importantly, it helps keep consumers’ price expectations in positive territory, which avoids the negative growth spiral I mentioned before. It should also eventually lead to higher stock prices, which boosts investor confidence.

Granted, deflation is not an issue for most of the emerging world. Inflation in India is rising at nearly 10 per cent annually, Argentina 11 per cent and Turkey 9.2 per cent. Higher commodity prices would most likely require higher interest rates, thereby putting more upward pressure on their currencies.

But short-term pain can be long-term gain. Deflation would depress demand in the developing world, which is negative for exporting emerging economies. It’s in their interest to want strong developed markets, and a weaker dollar is one way to get this. Hopefully, the IMF meeting this weekend will see the world’s top finance ministers find a cordial solution to the “currency war” that takes note of the fact that developed economies need a weak dollar to re-flate their economies.

Comments

If the stated value, of “Federal” Reserve notes, declines enough with respect to copper and nickel, the 1946-2010 U.S. Mint nickels, composed of cupronickel alloy, could become somewhat rare in mass circulation.

The October 8th metal value of these nickels is “$0.0617794″ or 123.55% of face value, according to the “United States Circulating Coinage Intrinsic Value Table” at Coinflation.com.

Posted by dpwozney | Report as abusive
 

Is the author smoking pot? Weaker dollar is good ONLY for united states. Where NO ONE has any savings and only debt. Yeah, it would be sooo simple to lie out of the debt by devaluation…. today’s debt dollar worth only half tomorrow………. imagine the other side – Would you – AMERICAN CREDITOR – would want to see your investment halved? That out of every dollar you invest you get 50cents back? INCLUDING principal?

Posted by sane2go | Report as abusive
 

Kathleen, you missed the point on what Premier Wen said. I’ll say it again for you: “a rapid strengthening of the renminbi against the dollar would be a “disaster for the world.””
the key word here is ‘rapid’…. I know you (and many others missed it the first dozen times… No one in China is arguing that the rmb shouldn’t rise in value. They’re only arguing that a “rapid increase in value, would throw China’s economy (and thereby its social stability) into chaos. If this were to happen, the entire world would feel the pinch….
Do you get it yet???? Rapid….

Posted by edgyinchina | Report as abusive
 

There is no quick fix to this problem. Transfer of technical knowledge has accelerated the relocation of industrial manufacturing. China has low cost labor, the latest state of the art manufacturing machinery, the technical knowledge we provided and oodles of our money. The west has helped China build their industrial juggernaut and major multi-national companies around the world now rely on Chinese manufactured products & components to make a profit and pay dividends. Just because they are now the lowest cost bulk manufacturer of almost everything, we can’t say “Oops we need a do-over. Giving you all that technology was a bad idea”. There is no way to turn the clock back. Greed and a lust for low priced goods created this problem. The Yuan will slowly rise in value as the standard of living improves outside of the main cities in China. They will continue to expand with or without the approval of other counties. China will sell more and more of their manufactured products to developing countries to reduce its reliance on sales to USA and Europe. The west have dug themselves into a huge “debt hole” that will result in a lower standard of living in general and high unemployment. We need to accept the reality of the situation. The USA is printing money in an attempt to patch over the problem. That is also currency manipulation. Too late to single out China as a threat to world stability. A trade war and tariffs will make the situation worse. What if, as retaliation, China decides to more aggressively reduce its purchase of USA Government securities. By choking off imports from China that scenario will be self-fulfilling. And that will result in even higher unemployment.

Posted by QuePasa | Report as abusive
 

Economic crackpottery.

Posted by bro43 | Report as abusive
 

Units of currency are units of account in the economy to which the currency relates. If the overall value of an economy increases, while the number of currency units stays constant, then the value of the currency units will increase. Similarly, if the overall value of an economy decreases, while the number of currency units stays constant, then the value of the currency units will decrease. What is driving up the value of the currencies of fast-growing developing countries is their growth, and not the value of the dollar. What is driving down the value of the dollar relative to those currencies is the fact that the U.S. economy is not growing as fast as the economies of the fast-growing developing countries. It is true that the value of a currency may be affected by changing the number of units of the currency without changing the value of the economy (just like a 2:1 stock split cuts the value of a stock in half); however, the divergent growth rates between developed and developing economies appears to the be cause of the exchange rate differences we are seeing.

Posted by Bob9999 | Report as abusive
 
  •