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Why a Rising Dollar Isn’t Hurting the Economy

On my recent drive to catch a plane in Albany, I noticed a new sign on the side of an Interstate toll booth. It said “Canadian currency discounted 20%,” and it was taped directly over the previous sign, which used to say “Canadian currency discounted 10%.”

This is the most direct impact on everyday life that I have seen of the recent appreciation of the U.S. dollar. Since July of this year, the dollar has gained about 7 percent against the Canadian dollar (see chart 1).  For the first half of 2014, the exchange rate averaged about 1.09 Canadian dollars per U.S. dollar. But by early December, it rose to about 1.14 Canadian dollars per U.S. dollar. Hence the new sign on the toll booths around Albany.

Canadian dollar vs. U.S. dollar

Chart 1: Canadian dollar vs. U.S. dollar

The U.S. dollar has appreciated against other currencies as well. Chart 2 shows the value of the dollar against the basket of currencies of our major trading partners. A higher value means more expensive dollar, and since July, the dollar has gained about 11 percent.

Dollar gains ground against our trading partners

Chart 2: Dollar gains ground against other major currencies

What effect will the dollar’s appreciation have on the economy, other than that Canadians visiting New York State will have to pay more at the toll booth?

In general, a more expensive dollar makes American-made products more expensive for other countries, reducing exports. It also makes imported goods cheaper for Americans, stimulating imports. These effects alone would reduce net exports, and thus slow the GDP growth.

This sounds like bad news for the economy. But it isn’t. This is because exports are a fairly small part of the U.S. economy, and the appreciating dollar has other beneficial effects.

In fact, net exports of goods and services did not change all that much since the dollar started its upward march. During all of 2014, the U.S. trade deficit has fluctuated between -$39 billion and -$46 billion. The latest reading, in October, was about in the middle of this range, at -$43.4 billion. (The values are negative because imports exceed exports.) Net exports account for less than 3 percent of GDP, so small changes in net exports result in only tiny changes in GDP.

Moreover, a more expensive dollar has one important beneficial effect—it lowers prices of raw materials, most importantly oil. Since July, the price of oil and the price of gasoline fell by more than 25 percent. And cheaper oil and gas are good for the economy.

So, other than the tolls for the Canadians, the dollar’s appreciation has not so far harmed the growth of the U.S. economy, and unlikely to do any harm in the future.

5 Comments Post a comment
  1. Katy Delay #

    I do support a steady and strong dollar in the abstract, but that is not what we have. We have a fluctuating dollar. I wonder how this dollar reversal will effect emerging markets, especially the dollar carry trade. Phrased another way, what is the effect on global economic health of the see-sawing of the exchange rates among world currencies, especially now as the weakened US dollar seems to be headed towards an about-face, while the rest of the world has begun their exchange-rate-lowering interventions in earnest?

    Like

    December 12, 2014
    • Polina Vlasenko, PhD, Senior Research Fellow #

      Katy, yes, we do have a fluctuating dollar. And these fluctuations (essentially unpredictable) in the exchange rates of world currencies complicate international trade. The extent of the damage is hard to determine, but world trade would definitely be easier if exchange rates were stable or fixed and exchange rate risk non-existent.

      Like

      December 15, 2014
  2. Phililp Kolodziejski #

    Best of your most recent blogs explaining in understandable terms why a strong dollar will be in our best long term interest.

    Like

    December 12, 2014
  3. Good analysis up to and including the effect of the rising dollar on net exports. But the effect is greater in the Heartland when the dollar appreciates too much (up around 12 pct. year to date) or too fast (nearly all the increase has been since late August). Why is the Heartland affected by rising dollar? If you live in or near a port city, people tend to make a living related to trade by importing or exporting goods and services. The direction of the flow is less relevant because value is added by the act of importing or exporting, and local living standards are less affected by rising imports, falling imports (if offset by more exports), and the value of the dollar generally. Also, financial markets tend to like a strong currency because it tends to suck in “hot money” foreign investment capital in pursuit of greater gains in local stock and bond market investments through the rising currency.

    Meanwhile, out in the Heartland, we do not and cannot easily add value by the act of importing or exporting, and we do not run the stock market. We have to make goods and sell them in commerce (competing with imports) or raise crops or produce other commodities and sell them in markets whose prices usually are in dollars. In the case of commodities, remember that our producers’ input costs almost always are priced in dollars. However, for those same commodities, most of foreign producers’ input costs are in local currencies, most of which, by definition in a rising dollar environment, are falling vs. output prices offered in the global market. Also, the absolute level of those costs (land, labor, and even capital in some countries) often is lower than for producers in the United States. Compare the costs of producing corn or soybeans in Brazil vs. the United States, for example. At $4 a bushel for corn, most producers in the United States probably have difficulty breaking even; but with different and usually lower input costs in Brazil and a weaker currency besides, Brazilian producers might view $4 as still a great price for their corn. In international markets, Brazil (and not a few other countries) eats our lunch whenever the dollar is rising a lot and rapidly, as it is now.

    The United States is among the few countries that do not intervene directly in currency markets to affect the value of their own currencies. That is good because classical economic theory suggests that free markets are preserved only when no one intervenes. Also, in a classical gold standard international system, the system is automatically stable only if none of the major players intervenes. But even if we are generally virtuous in this regard, most others are not. At a conference ten years ago at AIER, Lord Robert Skidelsky (Keynes’s biographer) observed that, in an international system officially premised on freely floating exchange rates since the 1970s, only the United States and the United Kingdom even attempt to comply with the rules of the floating rates game. Many countries peg their currency rates to a perceptibly stronger regional or global currency, while others use a system of targeted foreign exchange market interventions to gain trading advantages over others (this system is called “dirty floating”).

    In such a world, the United States often finds itself in the position of the only honest man in a poker game. Perhaps the rising dollar has had little or no impact on living standards thus far, but if the trend persists, and we have had two episodes of severe overvaluation since 1980, roughly 1984-87 and roughly 1994-2002 from which to judge, it is fair to predict that, over time, life will go on quite nicely in the coastal regions, while manufacturing and agriculture (Heartland enterprises) experience another period of hollowing out.

    Watch the exchange traded U.S. dollar index, , currently between 88 and 89, and we shall see over time which view of the rising dollar proves correct. — Walker Todd

    Liked by 1 person

    December 13, 2014
    • Polina Vlasenko, PhD, Senior Research Fellow #

      Walker,
      thank you for pointing out that strong dollar does not affect all people/regions/industries equally. I still stand by my claim that the rising dollar so far has not hurt the U.S. economy overall. But you bring up a very important point — not hurting the economy overall does not mean that it is not hurting anybody at all. I would not dispute your claim that the stronger dollar is hurting the Heartland economy.

      Like

      December 15, 2014

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