Is the buck back?
Diana Furchtgott-Roth, former chief economist at the U.S. Department of Labor, is a senior fellow at the Hudson Institute. The opinions expressed here are her own.
âThe Buck is Back,â proclaimed a Wall Street Journal headline on Tuesday. But even if it is, and thatâs a big if, a strong currency is a mixed blessing.
True, in spite of the financial crisis, over the past six weeks the dollar has strengthened substantially against the euro and the British pound, although Wednesdayâs half percentage point Federal Reserve rate cut caused the dollar to slip. But the dollar has lost value relative to the Japanese yen.
Whatâs really happening is not that the dollar is strengthening on its merits, but that European currencies are weakening.
âFor the dollar to depreciate, it has to depreciate against another currency. America isnât looking great, but Europe is looking even worse,â explains American Enterprise Institute resident fellow Desmond Lachman.
Europeâs worsening economic problems â greater than Americaâs â are causing some investors and the army of regular foreign exchange speculators to prefer dollar assets, what foreign exchange traders call a âflight to quality.â
Approximately 40 percent of America’s subprime loans are held abroad; the British housing market is deteriorating; the British government is bailing out the City of Londonâs famed banking sector; and European banks hold risky investments in slowing Eastern European economies, especially Russia.
As a result, the European Central Bank is likely to cut interest rates soon, further dimming the attractiveness of the euro, and the Bank of England may well follow suit.
Although a stronger dollar might appeal to Americansâ patriotism and pride, it will have mixed consequences. It makes exports more expensive and imports cheaper, which implies lower economic growth and a loss of jobs in export industries.
The relative weakening of European currencies versus the dollar could hurt America more than Europeans.
Americaâs 2.8 percent annualized second quarter GDP growth rate was supported by exports, and third quarter GDP would have declined by more than three tenths of a percent without them. As consumers reduced spending, rising exports helped employment.
With a weaker currency, Europeans will see more Americans visiting for vacations and shopping trips, and it will be easier for Europeans to sell their products in American stores for Christmas â if the recession doesnât completely empty the stores of shoppers.
Japan, with its strong currency, is the country that may be in real trouble. With interest rates in Japan only at 0.3 percent, reduced on Friday from 0.5 percent, the Bank of Japan has little room to cut to let the yen fall against the dollar and the euro. In addition, its low interest rate makes the yen the currency of choice for hedge funds, which borrow yen and invest in euro- or dollar-denominated assets.
Some, such as Encima Global President David Malpass, criticize Washington for not doing more to promote a stronger dollar. The weak dollar, according to Malpass, was one of the major causes of the financial crisis, resulting in inflation, the asset price bubbles in commodities and housing, and withdrawal of capital from America. Although America benefited from exports, this was outweighed by damage done to other sectors of the economy.
Yet with the economy in recession, the Fed wonât raise interest rates soon to strengthen the dollar. Domestic considerations trump the dollar in determining economy policy.
As the global economy works its way out of a recession, Japan, with its strong yen, has more to lose than Europe, with its weak euro. As for the buck, it is not back, but it is fine where it is.
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