Dollar strength is weakness as euro migrates its slump

The US isn’t exactly booming but it looks great compared with Europe

Over the past year the dollar has risen 20 per cent on average against other major currencies; it’s up 27 per cent against the euro

Over the past year the dollar has risen 20 per cent on average against other major currencies; it’s up 27 per cent against the euro

 

We’ve been warned over and over that the Federal Reserve, in its effort to improve the economy, is “debasing” the dollar.

The archaic word itself tells you a lot about where the people issuing such warnings are coming from. It’s an allusion to the ancient practice of replacing pure gold or silver coins with “debased” coins in which the precious-metal content was adulterated with cheaper stuff. Message to the gold bugs and Ayn Rand disciples who dominate the Republican Party: that’s not how modern money works. Still, the Fed’s critics keep insisting that easy-money policies will lead to a plunging dollar.

Reality, however, keeps declining to oblige. Far from heading downstairs to debasement the dollar has soared through the roof. Over the past year it has risen 20 per cent, on average, against other major currencies; it’s up 27 per cent against the euro. Hooray for the strong dollar!

Or not. Actually the strong dollar is bad for the US. In an immediate sense it will weaken the long-delayed economic recovery by widening the trade deficit. In a deeper sense the message from the dollar’s surge is that we’re less insulated than many thought from problems overseas. In particular you should think of the strong dollar/weak euro combination as the way Europe exports its troubles to the rest of the world.

Some background: US growth has improved lately, with employment rising at a pace not seen since the Clinton years. Yet the state of the economy still leaves a lot to be desired. In particular, the absence of much evidence for rising wages tells us that the job market is still weak despite the fall in the headline unemployment rate. Meanwhile, the returns the US offers investors are ridiculously low by historical standards, with even long-term bonds paying only a bit more than 2 per cent interest.

Looks great

United States

Even before the new Greek crisis blew up Europe was starting to resemble Japan without the social cohesion: within the euro zone the working-age population is shrinking, investment is weak, and much of the region is flirting with deflation.

Markets have responded to those poor prospects by pushing interest rates incredibly low. In fact many European bonds are now offering negative interest rates.

This remarkable situation makes even those low, low US returns look attractive by comparison. So capital is heading our way, driving the euro down and the dollar up.

Who wins from this market move? Europe: a weaker euro makes European industry more competitive against rivals, boosting both exports and firms that compete with imports, and the effect is to mitigate the euro slump.

Who loses? We do as our industry loses competitiveness, not just in European markets but in countries where our exports compete with theirs.

America has been experiencing a modest manufacturing revival in recent years, but that revival will be cut short if the dollar stays high for long.

Stagnation

And the effects may be quite large. If markets believe that Europe’s weakness will last a long time we would expect the euro to fall and the dollar to rise enough to eliminate much if not most of the difference in interest rates, which would mean severely crimping US growth.

One thing that worries me is that I’m not at all sure that policymakers have fully taken the implications of a rising dollar into account. The Fed, still eager to raise interest rates despite low inflation and stagnant wages, seems to me to be too sanguine about the economic drag.

And the most recent Fed minutes suggested that some members of the committee that governs monetary policy were thoroughly clueless, apparently believing that inflows of capital would make the US economy stronger, not weaker.

Oh, and one more thing: a lot of businesses around the world have borrowed heavily in dollars, which means that a rising dollar may create a whole new set of debt crises. Just what the global economy needed.

Is there a policy moral to all this? One thing is that it’s really important for all of us that Mario Draghi at the European Central Bank and associates succeed in steering Europe away from a deflationary trap; the euro is their currency but it turns out to be our problem. Mainly, though, this is another reason for the Fed to fight the urge to pretend that the crisis is over. Don’t raise rates until you see the whites of inflation’s eyes!

© 2015 New York Times News Service

The Irish Times Logo
Commenting on The Irish Times has changed. To comment you must now be an Irish Times subscriber.
SUBSCRIBE
GO BACK
Error Image
The account details entered are not currently associated with an Irish Times subscription. Please subscribe to sign in to comment.
Comment Sign In

Forgot password?
The Irish Times Logo
Thank you
You should receive instructions for resetting your password. When you have reset your password, you can Sign In.
The Irish Times Logo
Please choose a screen name. This name will appear beside any comments you post. Your screen name should follow the standards set out in our community standards.
Screen Name Selection

Hello

Please choose a screen name. This name will appear beside any comments you post. Your screen name should follow the standards set out in our community standards.

The Irish Times Logo
Commenting on The Irish Times has changed. To comment you must now be an Irish Times subscriber.
SUBSCRIBE
Forgot Password
Please enter your email address so we can send you a link to reset your password.

Sign In

Your Comments
We reserve the right to remove any content at any time from this Community, including without limitation if it violates the Community Standards. We ask that you report content that you in good faith believe violates the above rules by clicking the Flag link next to the offending comment or by filling out this form. New comments are only accepted for 3 days from the date of publication.