Usa Strong Dollar versus Weak Dollar Policy Assignment Sample

International Monetary Economics - Position Paper

Introduction to International Monetary Economics

Around the world, currency exchange rates are constantly in flux, including the US dollar. This exchange rate refers to the value of one currency versus the currency of another country or economic zone. The terms 'weakened' and 'strengthened' are used to describe a change in the exchange rate, which affect different stakeholder in a different manner according to the change direction (Habib, Mileva & Stracca, 2017). Nations take an active interest in the relative value of their currency mainly because it influences the decisions of businesses, government and individuals. In a collective manner, it affects inflation, economic activity and the balance of payments (Dai, Delpachitra & Cottrell, 2017). Therefore, nations make changes in their monetary policy to influence the value of their currency by changing interest rates and economic policies. While one might think that nations would always opt for a strong currency, it is not always the case which makes the topic more complicated in theory and practice.

The implications of words like 'weak' and 'strong' can be misleading for people who believe that appreciating currency is better for the economy, while a depreciating one is not. In fact, there is no simple connection between the strength of an economy and the strength of economy's currency, which creates the problem of setting an exchange that can support the economy in the according to the overall economic environment (Lee & Yue, 2017). This problem is evident in the current political environment, considering that US president Donald Trump does not have a consistent and coherent policy for the same and tends to shift from time to time in favour of strong dollar or a weak one. This paper argues that the US should opt for monetary policy which makes the dollar stronger in order to stabilize the economy in the current economic environment.

Argument Against a Weaker Dollar

The demand of Trump for a weaker exchange rate was primarily based on the faulty notion that a weak dollar will confer a sustainable advantage by promoting exports and limiting exports, and that better exports are the key for economic success. However, in practice, the policy of intentionally depreciating the value of the US dollar will make daily life in America more difficult (Seraj, Coskuner, Akadiri & Bahadori, 2020). A weak dollar will not only make travelling to foreign more expensive, but it will also result in increased prices for tradable goods such as shoes, cars, clothing, vegetables and fresh fruits, which loom large in family budgets. This will adversely affect the American population, especially the poorest. Moreover, higher prices for these goods will also lead to lower real wages for US labours (Tunc & Solakogly, 2016).

In addition to this, since more than half of the imported goods in America are used for production, rather than consumption, such as capital machinery, raw materials and intermediate inputs (Khademalomoom & Narayan, 2020). A weaker dollar also means increased production costs for American producers. It will also result in higher prices for necessary inputs such as oil, which, in turn, will make the cost of production and household for consuming energy (Tuomainen, 2017). Likewise, the depreciating dollar also negatively affect America's terms of trade (TOT) with respect to the rest of the world. TOT measures the prices of US exports divided by the prices of imports in the US. This determines, for instance, the number of shoes America can import from India for each ton of soybeans it exports there. Contrary to common sense, the advocates of weaker dollar want people to believe that Americans are somehow richer if they can only buy 20 pairs, instead of 25 pairs of shoes for every ton of soybeans (Liu & Shaliastovich, 2017).

Also, in the short run, an artificially depreciated dollar can improve the exports, but the extra currency used to decrease the exchange rate can increase the inflation which, in turn, cancels out the advantage from the nominal exchange rate. Ultimately, the actions of the central bank will only a fleeting and limited impact on the real value of the currency (Tokic, 2019).

Likewise, using the Real Trade Weighted US dollar index as a benchmark, one can see that there appears to be no significant change in the performance of the economy whether the dollar is strong or weak. In quarters with weaker dollar index than 1990-2019 average, the annualized GDP is on average 2.3 per cent, while in quarters with the strong dollar it is 2.7 per cent (Papadimitriou, Nikiforos & Zezza, 2020). Besides, in the last 4 quarters of America under Trump, the average growth of US GDP is a healthy 3.2 per cent, while the real value of the dollar has been more than 6 per cent above average (Siddiqui, 2020).

Sun and Kim (2018), in a more rigorous academic inquiry in the effects of weak exchange rate on US economy, mentioned that even though currency depreciation can give short term boost for production, in the long run, such effects are dissipated by declining consumption and rising inflation with no impact on the trade balance. On the other hand, a strong dollar can be good for numerous reasons. When foreigners are not using US dollar to purchase exports from the US, they use them to invest in America; in US real estate, bonds, stocks and foreign affiliate-owned factories in America. An appreciating dollar not only reflects its utility as a means of global exchange but also the confidence of the world in America as a safe place for wealth investment (Li & Niu, 2020).

Case for A Stronger Dollar

Global Pandemic and Liquidity Injection:

Considering that a weak dollar is not beneficial for the US economy, the option is to make the dollar stronger as compared to other currencies in order to boost the American economy. This is especially pertinent considering the current economic environment which is severely affected by the global pandemic (McKibbin & Fernando, 2020). The current economic scenario is riddled with slumped economic activity and increasing unemployment. Within the past 6 weeks, a total of 30 million Americans have filed unemployment claim, and the US congressional budget office predicts that more than 15 per cent of total US population can get unemployed by this year’s third quarter (Nicola et al., 2020).

This is a whopping increment of more than 10 per cent in the unemployment rate from the first quarter. In this situation, even the short-run competitive advantage of a weaker dollar offers limited utility to exporters. This is so mainly because if no one's buying at any prices, then using a weaker currency to secure price advantage is more or less irrelevant. This will only change with a return to some degree of economic normalcy, and as the below-mentioned chart illustrates.

America and the world is a long way from achieving that. The adverse effect of the pandemic is evident in the case of China which is the first nation to suffer from the depredations of the virus and the first to somewhat control its spread. The year on year decline in china was 7.5 per cent in April, which is an improvement from 15.8 per cent decline in March, but worse than the 6 per cent fall expected by analysts (Barua, 2020).

This negative impact on Chinese households, and indeed across the globe, means that in the short run, households will try to rebuild their domestic finances by curbing expenditure. The phrase 'across the globe' is used here because even though economies differ in terms of scale and governance, the underlying economic functions are similar everywhere, whether it be China or US. This reduction in expenditure will reduce aggregate demand which will have a negative effect on the production as manufacturers will reduce the scale of their activities. This ultimately leads to the concept known as "paradox of thrift", which further exacerbates the economic problem (Saharuddin & Rama, 2017). Moreover, restoring the confidence of consumers will not happen overnight. Meanwhile, central banks in major economies like Australia and the US are cutting interest rates and restarting quantitative easing to make sure that financial systems have cheap liquidity.

The US alone has cut rates to zero and is launching a massive $700 billion quantitative easing program (CNBC, 2020). In order to do so will require debt buyers, and although China has been a huge buyer of American debt, US cannot assume that China will step up again because of the economic problems in China and strained relationship among both of the nations. Therefore, it is important for Donald Trump to create an attractive environment by making the dollar stronger, as potential foreign buyers will be happier to buy US dollar if they feel that is going to stay strong. Hence it will be better for the US to make the dollar stronger in order to inject money into the economy, to support industries during the period of aggregate demand (Thornton & di Tommaso, 2018).

Long Term and Short Term Perspective

In addition to this, while the supporter of weak currency proclaims that it stimulates the economy and support exports in the short run, they often forget the impact of beggar thy neighbour policies which resulted in competitive devaluations and consequently leaving everyone worse off (Mattoo, Mishra & Subramanian, 2017). Proponents of currency devaluation approach the problem from a scarcity mindset and assume that economics is a zero-sum game, and neglect that import and exports are supposed to be beneficial for both the exporting and the importing nation. Furthermore, no one talks about the positive economic impacts of a relatively stronger currency; that it makes domestic markets more efficient, which is necessary for long-run sustainable growth of an economy. Simply put, a stronger currency makes it difficult for exports, which encourages them to get leaner and more competitive with foreign players (Mattoo et al., 2017).

Taking such a long term view might be difficult for policymakers since it is unpopular in the short term. The most basic and core assumptions of a short term view favouring weaker dollar is reflected in the first speech of Janet Yellen, as chair of the Federal Reserve in 2014. In her speech, Yellen mentioned that by keeping the interest rates low, they (Federal Reserve) are trying to revive the housing market and making homes more affordable. Low-interest rates will also make it cheaper for a businessman to expand, hire and build. This will help to revive the industry and enable American households to afford things they need which will create even more spending and will strengthen the economy (The World Bank, 2020).Even though from the outside this might appear a strong logical approach to support the economy, but one has to notice the constant presence of the short term perception throughout the speech.

The biggest argument in the support of a weaker currency is also its biggest drawback. Since the weak currency ideology only perceives the short term benefits it provides to the economy, it tends to make the industries more dependent on monetary policy and makes the economy less sustainable for the long run. In the short run, a weaker currency might make the economic condition appear more positive with protection to manufacturers and huge profit margins. However, it also leads to the increased cost of production, as manufacturers hire too many people and do not strive for cost-effectiveness, as they are protected by weak currencies, and facilitates the economic growth which is largely based on high asset prices and speculation, instead of real economic growth.

Overall Economic Strength

Currencies can be perceived as the relative stock value of an economy. US dollar will be relatively much stronger than other currencies if the market is optimistic in the US economy. The market believes in the development and growth of the economy, therefore, the value of a currency is influenced by government decisions. A weak dollar sends a negative message to the global investors and threatens the dominance of the dollar as the currency of exchange (Saharuddin & Rama, 2017). A weak dollar means that Americans will lose significant spending power and since Americans buy many imported goods, it will also result in an inflationary effect. This is so mainly because the prices of services and goods will experience an increment due to depreciation of the dollar and will subsequently lead to negative wealth shock (Mattoo, Mishra & Subramanian, 2017b). Also, even though a weak dollar may help US exporters in the short run as American goods will get cheaper, the increased demand may also result in an increment in prices of goods and services denominated in dollar, which will increase the prices for the American population.

Moreover, consumption in America, due to increase prices of imported goods, might shift towards a reduction in the consumption of domestic goods, in order to keep consuming the preferred foreign goods. On the other hand, a relatively stronger dollar makes US population more wealth as they can consume more imported goods. The strong currency also keeps the US at the top of the currency food chain because the relative strength of a currency is what makes it worth holding (Barua, 2020). This is especially true in the current scenario in which due to the pandemic, major central banks have reduced the interest rates to near zero, and at the same time governments have launched unprecedented programs for expenditure. Basically, the focus has shifted from competitiveness and trade to financing ballooning deficits. Currently, it is of supreme importance that investors do not lose faith in the US financial system, and the ability of the US government to repay its debt (CNBC, 2020). This, in turn, makes a strong dollar policy sound, even for the short term.

As Papadimitriou, Nikiforos and Zezza (2020) mentioned, a strong dollar reflects a world where people want to invest in the US; foreign investor sees US stocks and bonds as more attractive and is even willing to forgo their currency for better returns. Besides, while it is clear that exports are important for workers and firms, exports only represent 13 per cent of the overall GDP of America, while the consumption in the US contributes around 2/3 of the total GDP, which broadly benefits form a stronger and stable dollar (Habib, Mileva & Stracca, 2017). Hence, a much better strategy would be to keep the dollar stronger while using other economic strategies such as tax redemptions etc. to support firms that are dependent on exports, and encouraging such firms to become more competitive through innovative business practice and cost-effectiveness. Also, a weaker dollar can lead to high commodity prices and high inflation expectations, which might be good news for firms, but not so good for average American. At the same time, if a weaker dollar translated to high inflationary pressure, it can result in tightening monetary policy as higher interest rates are welcomed by savers but by anyone who needs to pay it back (Seraj, Coskuner, Akadiri & Bahadori, 202).

Conclusion on International Monetary Economics

In conclusion, by analysing the market economics from a long term perspective, one can understand that a stronger dollar will be better for the sustained growth of America, or any other economy. A relatively stronger currency is important for attracting investors and supporting the economy. It also makes the domestic economy more competitive and efficient which is also a necessary component of a sound economic system. By opting for a monetary policy which makes the US dollar stronger in the international market, Trump can attract potential buyers to support the quantitative easing program. Without adequate liquidity, America will not have the resources to support its industries and manufacturing sector during this global decline and will be unable to recover from the same. In addition to this, it will also encourage American domestic industry to become more efficient and cost-effective, which will further improve the position of America in the global marketplace.

Furthermore, strong dollar policy is recommended for the US considering that it needs to inject a massive amount of cash in the economy and it is important to attract investor in order to do. A strong dollar represents the strength of the US economy and the ability of its government to repay loans. Therefore, a strong dollar will help the US to stimulate its economy and will support its industries during this period of declining aggregate demand and increasing unemployment. The underlying logic behind this recommendation is that not only does it supports the long term economic sustainability of American economy, it is also beneficial for tackling the adverse effect of the global pandemic in the short run. Apart from this, it is much better to strengthen the fundamentals instead of making the country poorer by putting its goods for sale. This view is succulently described by the remark of former chief economist of the World Bank, Lawrence Summers, that no nation can devalue its way to prosperity.

References for International Monetary Economics

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