A strong dollar, free trade, and economic tradeoffs
I have long been an advocate for the idea that there is no such thing as a “solution.” Realistically, every policy choice involves tradeoffs only – not solutions. However, it is all too common that only one side of an issue is considered, leading to an inaccurate depiction of those critical tradeoffs.
I was lately spurred into thinking about this in the context of trade policy when reading David Malpass’s column in the Wall Street Journal, called “Ron Paul, the Fed and the Need for a Stable Dollar.” In pertinent part:
Dollar weakness doesn’t work at all for economic well-being. The corollary to the Fed’s policy of manipulating interest rates downward at the expense of savers is declining median incomes. It’s no coincidence that inflation-adjusted median incomes rose in the sound-money booms of the Reagan and Clinton administrations and fell in the weak-dollar busts during the Carter, Bush and Obama years. When the currency weakens, the prices of staples rise faster than wages, hurting all but the rich who buy protection.
The economy and median incomes would do much better if the Fed said simply that it would set interest rates as best it could in order to keep the dollar’s value strong and stable in coming decades, with the goal of attracting capital, maintaining price stability and encouraging full employment.
Dollar weakness is very often touted by bad economists as a way for the economy to grow through export, or (far more pernicious) a way for governments to inflate their way out of fiscal mistakes. Both are true enough.
But what good is an increase in exports if we do not examine the correlated tradeoffs? Weak dollars mean propping up export-driven businesses artificially, and this supports some jobs. But as Malpass points out, commodity prices rise faster than wages, reducing real wealth for everyone, including those whose jobs are being supported.
Furthermore, as Malpass notes, manipulating interest rates downward in the service of a weak dollar is an implicit tax on savers. This leads to over-stimulated current demand, and this skewed time preference precludes valuable investment in the economy that would sustain real wealth over the long term.
And speaking of investment, it is worth noting that running a current account deficit requires running a capital account surplus. The dollars that do not come back to this country as payment for what we do export come back as investments. The last few decades have shown that, in times of high current account deficits (importing over exporting), the United States has experienced relatively higher growth than when the current account deficits were low.
This manifests itself in higher GDP growth, a higher stock market, higher job growth, and higher manufacturing output. Consider this last. Those who insist on examining only one side of the equation insist that weaker dollars and export-driven economy lead to more manufacturing employment, since we can ship our products overseas.
What they do not see, or do not acknowledge, is that the capital investment required to sustain manufacturing employment over the long run often comes from foreign investors looking for a place to invest the dollars they received when we imported their goods.
I would argue that the advantages of a stable dollar policy (growth, employment, standard of living) outweigh the advantages of a weak dollar policy (preservation of some preexisting jobs, political talking points). And the downsides to weak dollar policy (bias against savings, bias toward government spending) are disconcerting too. All in all, I do not find this to be a tradeoff worth making.