Should United States pressure other countries to unpegged their currency to the dollar?

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CONOMISTS, chief executives and Washington policy makers have hailed the weakened dollar as good news for the United States. After all, when the dollar loses value against the euro or the British pound, for instance, it should make American-made goods cost less in markets that use those currencies. Cheaper prices should stimulate bigger orders for American companies, especially those in the hard-hit manufacturing sector. And, as manufacturers exhaust their ability to produce more goods without adding labor, the pace of job creation should accelerate.

It sounds simple enough. But as is often the case, what economic theory says and what happens are two different things. "There are a lot of weak links in the chain between exchange rates and jobs," said Catherine L. Mann, senior fellow at the Institute for International Economics, based in Washington.

Just because the euro rises 36 percent against the dollar - as it has since the beginning of 2002 - does not mean that American exports to the euro zone will rise by that amount in the same time frame. Last January, exports from the United States to the 15-nation European Union amounted to a strong $12.53 billion, up 6.3 percent from January 2003. And for all of 2003, American exports to the region rose 4.7 percent. Yet over the year, the euro rose 20 percent against the dollar.

First, trade between the United States and Europe - the two wealthiest and most developed markets in the world - is not the relatively simple trans-Atlantic trade that it was for centuries. Because many nations today - most notably China - link their currencies to the dollar, a decline in the dollar does not necessarily give the United States a competitive advantage on the Continent.

"While we may be able to lower our prices in Europe because of the stronger euro, so can every Asian country that pegs its currency to the dollar," said Ethan S. Harris, chief United States economist at Lehman Brothers.

And because a large and growing chunk of American exports goes to countries whose exchange rates are pegged to the dollar, the decline of the dollar against the pound, for instance, simply does not have the same impact on domestic producers that it might have had two decades ago. "The share of our trade with the developing world has increased substantially over time," Dr. Mann said. "Europe isn't as important as it used to be."

Second, currency shifts often do not translate directly into changed prices for consumers. When the euro strengthens by 10 percent against the dollar, the price a shopper pays for a bottle of Beringer wine at a liquor store in Dortmund, Germany, will not necessarily fall. "People who import the American-made goods take the opportunity to keep prices steady and increase their profits," said M. Cary Leahey, senior economist at Deutsche Bank.

THIRD, while we may live in an age of just-in-time inventory and instantaneous communication, when it comes to packing and shipping crates and containers of goods on huge boats across large bodies of water, the pace is a little slower. And a great deal of international trade is bound by contracts that fix prices for long periods.

"People make decisions on where to source their components in advance and tie themselves into contracts that last for several months or years," said Ian C. Shepherdson, chief United States economist at High Frequency Economics, based in Valhalla, N.Y.

That is why economists say it can take up to two years for significant currency shifts to wend their way into trade figures. Finally, it isn't just the price of goods that dictates how much you buy; it's also the amount of cash jingling in your pocket. Here again, Europe - whose comparatively high-income population should make it a natural destination for American-made goods - has been lagging.

For several years, Europe's slow growth has turned it into a heavy caboose slowing the train of global growth. And with the European Central Bank predicting growth of just 1.8 percent for 2004, we should not expect demand for American exports to rise sharply, regardless of whether the dollar slips further against its rival trans-Atlantic currencies.

The weakened dollar is having its expected effect. Over all, United States exports rose 4.58 percent in 2003, to $1.018 trillion, according to the Census Bureau. And in January 2004, exports were 8.5 percent higher than they were in January 2003. But the enfeebled greenback may not be working its magic quickly enough for a nation that has grown impatient for job growth.

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OK, I'll bite.
What about currency movements would you like to discuss?

As to your main question - should US pressure other countries to abandon their peg to the dollar?
The short answer is - no.

Pegging a currency, or using a basket of currencies is beneficial because it promotes stability in the international financial system. Also, with stable currencies, people can trade goods and services between countries more efficiently (in economic terms). IOW, stable currencies mean people trade on economic value rather than on financially driven price advantages.

The downside of pegging a currency is that it takes away an instrument of monetary policy. For most countries this is actually a good thing because it keeps the politicians out of international financial relations, and keeps the politicians from manipulating currencies to the detriment of their own citizens.

However, some countries that peg to the US dollar may pay a price when the dollar is devalued. If a country has a lot of trade with countries other than the US, then the dollar peg will hurt their import market just like it does ours. Conversely though, it would benefit their export market.

Is there a downside to the US economy when countries peg their currency to the dollar?
I don't think so.
The big negative is that US firms cannot benefit (or lose) from shifts in the value of currencies. If a company has a real economic advantage operating in a given country, a long-lasting movement in currency values should have little effect on the competitive health of the company. For competitively weaker companies and industries though, long-lasting shifts in currency values can effect fundamental change in economic relationships between and within countries. Although being able to benefit from devaluations may help some industries at certain times in their production cycles (I am thinking agriculture, for example), most industries benefit from price stability, whether in domestic or foreign markets. The point is, (volatile) currency movements benefit few people except for banks, fx traders, and hedge funds.

Just my .02
(which used to buy a lot more overseas than it does now!)

I don't think that exchange rate movements are related to employment. However, long-term shifts in exchange rate relationships may impact employment and activity in different sectors of the economy (as I mention in my previous post).

I am generally a supporter of floating exchange rates. Some countries benefit from a peg, especially those countries with smaller economies. The problem for countries that are trying to embrace capitalism, welcome foreign investment, and improve the lot of their people, is that the global foreign exchange markets are large enough to dwarf these small economies and instigate speculative financial crisis.

In the case of China, it would be preferable for the world trading system if they were to float their currency and make it fully convertible in the fx markets. As the significance of China's economy has grown, and they have become increasingly integrated into the world trading system, the peg raises some concerns. Ironically, although the peg adds certainty about the current value of the RMB, at the same time, the arbitrary nature of the peg adds uncertainty with respect to Chinese response to changes in their macroeconomic outlook. Recently, there has been concern about inflation in China, which had some analysts concerned they would change their peg. The immediate inflation fears have subsided, but the future decisions of the Chinese government remain an uncertainty.
If China wants to be part of WTO, then they should float their currency and make if fully convertible.

The unfortunate reality for US manufacturing workers is that technology has been a greater force in the destruction of jobs. While the gains in productivity are welcome news to the overall health of the US economy, it is a bitter pill for many Americans to swallow. We are, afterall, accustomed to, and cultured to have work and lifestyle like our fathers and their fathers did. (IOW, granpa and pa worked down to the factory in town, so that's where I belong too.)

Flexibility and innovation are the cornerstones of the US economy, but this very strength for the US economy displaces workers and takes them out of their comfort zones. (Hence they run to the Dem party, which claims to act in their interest.) The real shame of it is that the US education system has become wholly inadequate , and leaves too many people unable to pursue new occupations themselves. (Hence, we have the Dems clamoring all the time for government job training programs.) If people were properly educated from the get-go, they would be empowered for lifetime learning and require little, if any, assistance from the government for job (re)training.

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