The war the US is not fighting
“The US is losing the currency war” is the title of an article published on 2 February by the German news magazine Die Zeit. Indeed, the mighty US dollar, which has appreciated almost 20% on a trade-weighted basis since June, seems to pose a tremendous challenge to the US. Die Zeit is even hinting at the possibility of the US economy stalling. But does the US really have to worry?
Usually, a 20% rise in the value of a currency in the span of several months will hurt an economy. Take the case of Switzerland, where the latest PMI dropped from a solid 54 level to a dismal 48 in the weeks after the Swiss National Bank abandoned the euro/Swiss franc floor.
However, we are not talking about a small economy but rather the world’s leading one, and not a minor currency like the Swiss franc, the Swedish krona or the Malaysian ringgit but the mighty US dollar. And mighty it is. The greenback remains by far the world’s dominant currency, accounting for over 60% of global currency reserves and roughly 80% of global trade, with almost all oil trade conducted in it.
Discussing the value of a dollar doesn’t make much sense to the average resident of Illinois or Nevada. Less than 50% of US citizens hold a passport, so why would they care about the exchange rate? A dollar is a dollar, period.
Of course, US exporters do care, as do some US politicians. We might increasingly hear that the currency’s strength is harming company results or causing a more sluggish-than-expected economic recovery. But a suspicion remains that those excuses might hide other, more serious issues. It is better to blame the currency (meaning those foreigners not playing by the rules) than homemade errors. Moreover, the complaints of companies and politicians are at odds with what is actually happening in the US, where we expect growth this year to clear the 3% mark and the unemployment rate to retreat to 5%.
This growth derives first and foremost from domestic demand. The US is a large economy that doesn’t rely on foreign trade. Exports in goods and services haven’t sparked a US recovery since World War II. They are small relative to other growth components, only accounting for 13.6% of GDP (in 2013 terms). To put it another way, one percentage point of growth in domestic demand has the same effect on GDP as 7.6 percentage points of export growth. Even if one accounts for the portion of this domestic demand covered by imports, the ratio of domestic demand to exports remains large (over 6.3).
In comparison, the extent of the Eurozone’s or China’s exports of goods and services in relation to GDP is almost twice as large as the US’s. Yet even in these two economies, domestic demand fuels growth: a one percentage point increase in domestic demand achieves almost four times more than a one percentage point rise in the export of goods and services.
In addition to this macroeconomic accounting, there is another argument for the US refusing to concern itself with the strength of the dollar. It has become a cliché for politicians worldwide to stress the need to grow their economies through exports. This is the goal of every nation engaged in the “currency war.” The larger a country’s trade surplus, the better its standing. Countries with trade deficits (like the US) are considered “losers” of the war.
Some “winning countries” even cloak this idea in moral terms by suggesting that surpluses reflect the virtues of hard work and frugality. Deficits, by contrast, hint of laziness and indulgence. But this self-righteous attitude patronizes the inhabitants of the deficit countries (not a constructive attitude if you want to trade). It also defies the logic that the surpluses of one country have to match the deficits of another country, unless Earth starts to trade with Mars or Saturn.
Finally it is worth noting that surplus countries tend to become creditors and deficit countries debtors. Hence, what surplus countries get in return for part of their exports is debt from the deficit countries. But one lesson the euro crisis should have taught us by now is that debt might not necessarily be honored in the long run.
All in all, the attitude of the US regarding the “currency war” seems to me to be the right one: keep cool, carry on, focus on your domestic demand and let other countries fight the war. Let them work hard to accumulate claims on debt in US dollars, which might or might not get paid back later.