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April 06, 2009


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"The exchange rate of the dollar would of course fall if China sold Treasuries, but right now that would be an unambiguously good thing."

To whom? I'm good with it, but I've been rooting for a weaker dollar for some time now. But as you said, the Chinese appear to be doing the St. Augustine bit....

Point taken. "An unambiguously good thing for:

(a) Americans who work in export or import-competing industries;

(b) Unemployed Americans who would like jobs in export or import-competing industries, and those concerned about them;

(c) American taxpayers, probably, under some assumptions that are probably true but that I'm too lazy to list right now;

(d) Americans who own foreign-currency assets.

It would be bad for:

(a) Foreigners who own dollar assets;

(b) Foreigners who work in exporting or import-competing industries;

(c) Americans who possess foreign-currency liabilities;

(d) Americans who purchase imports with a high CIF price relative to their retail price. (E.g., not Nike sneakers or iPhones, but maybe a $10 T-shirt or $11,000 car or Kobe beef or something.)

Of course, you've nailed the fact that the Chinese aren't about to do anything that might weaken the dollar. Hot hot air.

Hi Noel,

This is a silly question, from someone who doesn't really get economics.

Does a weaker dollar necessarily help America? A weaker dollar would mean the costs of raw materials for American products would go up as well, no?

(Oh, this is Faeelin).

Not silly at all. I was way too glib.

Depreciation is unambiguously bad for firms that sell to the domestic market and face no foreign competition. The real income of their customers goes down, and the dollar price of their imported inputs goes up.

Depreciation is unambiguously good for firms that sell to the export market. The real income of their customers goes up, and the foreign currency price of their domestic imputs goes down, and the dollar value of the foreign currency they earn goes up.

Depreciation is ambiguous (but probably postive) for firms that sell to the domestic market and face foreign competition. The real income of their customers goes down, and the dollar price of their imported inputs go up. But the dollar costs faced by their competitors go up even more.

The question, then, is do the benefits of depreciation outweigh the costs across the entire economy?

Right now, I'd say the costs of depreciation to a firm in the first category are pretty small. Since consumers have cut back on their import purchases pretty drastically, a depreciation won't make them much poorer. (The intuition is that imports now make up little of what they consume.) And most firms oriented to the domestic market are service firms, and don't use a whole lot of imported inputs, save energy, which is dirt cheap right now.

On the other hand, the benefits to firms that either export or compete with imports could be pretty large. Especially the latter.

If the dollar falls, doesn't fuel cost rise? Won't that have an overarching effect on the American economy?

This is weird. I know I answered this question, and now it's gone.

Your intuition is spot-on. Since the U.S. imports energy, a drop in the dollar should raise the price of energy.

As an empirical matter, however, that doesn't happen. (More accurately, it happens less than you'd expect --- a fall in the dollar produces a much much smaller rise in energy prices, and vice versa.) There are two reasons for that, one of which makes sense, and one of which doesn't.

The one that makes sense is that the U.S. forms a huge chunk of world energy demand, particularly oil. (26%, in fact, of which we produce two-fifths at home.) So when American demand for oil falls, so does the price of oil. This greatly cushions price swings.

The one that doesn't make sense, but may nonetheless be true, is that oil is priced in dollars. In addition, the Gulf oil-producing nations have fixed exchange rates with the dollar. For reasons that are not really clear to me, many argue that this institutional fact further protects the U.S. from having swings in the exchange rate feed through into energy prices. I don't follow the logic --- markets have to be very inefficient for it to be true --- but we've seen a lot of inefficient markets in recent days so I'm reluctant to dismiss the argument offhand.

I'll add, just to make things complicated, that since 2001 it does indeed look as though the trade-weighted exchange rate and the price of oil have been negatively corollated. I doubt there's much causality there, however. Oil demand and the exchange rate have been moved by the same underlying factors, rather than causing each other.

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