Tuesday, December 07, 2004

Weak Dollar Good For Exports? Maybe, But...

Simplistics economism overlooks quote a few things regarding exchange rate changes and their effects on deficits. For example, a falling dollar won't change much the situation in markets where quality counts over price. The export industry needs imports of raw materials and machine parts, which would be more costly. And even a commentary in neoliberal flagship The Economist warns:

Many American policymakers talk as though it is better to rely entirely on a falling dollar to solve, somehow, all their problems. Conceivably, it could happen—but such a one-sided remedy would most likely be far more painful than they imagine. America's challenge is not just to reduce its current-account deficit to a level which foreigners are happy to finance by buying more dollar assets, but also to persuade existing foreign creditors to hang on to their vast stock of dollar assets, estimated at almost $11 trillion. A fall in the dollar sufficient to close the current-account deficit might destroy its safe-haven status. If the dollar falls by another 30%, as some predict, it would amount to the biggest default in history: not a conventional default on debt service, but default by stealth, wiping trillions off the value of foreigners' dollar assets.

The dollar's loss of reserve-currency status would lead America's creditors to start cashing those cheques—and what an awful lot of cheques there are to cash. As that process gathered pace, the dollar could tumble further and further. American bond yields (long-term interest rates) would soar, quite likely causing a deep recession. Americans who favour a weak dollar should be careful what they wish for. Cutting the budget deficit looks cheap at the price.


Of course, since most investors' vision of reality is like that of cultists in some sect, it's most likely they continue to act like a toad in a bucket of water that is boiled slowly, and when they act they'll do it in panic.

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