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The Importance of Staying Strong on the Dollar

Presidio Economics | Friday May 6th, 2011 | 0 Comments

This post is part of a blogging series by economics students at the Presidio Graduate School’s MBA program. You can follow along here.

By: John R. Talbott

Last week, I was unfortunately exposed to AOLnews. I don’t take financial advice from Jim Cramer, and I usually ignore the sensational nastiness of daily financial reporting, but a friend had suggested that I watch this video about the decline of the dollar, so I did. Admittedly, I was incensed, but instead of complaining about what I saw, I thought it might be good to reflect on what I wish the news had said.

The Situation. Over the last two months, the US Dollar has declined against the Yen from JPY81.76 on March 1, 2011 to JPY81.15 on May 1 or -.7%. On March 11 you may remember, Japan suffered a devastating earthquake and tsunami which immediately created havoc in Japan’s financial markets. The Yen jumped to JPY85.24 on April 7, but returned to the pre-earthquake level by April 30, an indication that Japan’s economic institutions were stabilizing. But, from the point of view of AOLnews, that 5% in three weeks decline was news! The US Dollar is falling! To be fair, the US Dollar has weakened against the Euro during this time period (Fig 1), having fallen 7% over two months. The decline is real, even if the showboating is ridiculous. (Oanda) Let’s take a look at what AOLnews said and what I would have preferred to hear.

Is a Falling Dollar a Sign of Weakness? The AOLnews anchor, Jennifer Meckels, assumes that a falling US Dollar is a bad thing. The experts interviewed warn of things that might happen if the US Dollar falls further, but I wish they had analyzed the positive side of the falling US Dollar.

A falling dollar means the value of the US Dollar on currency exchange markets is declining. If the US is in an economic funk and other manufacturing economies are in inflationary cycles, do we really want to keep the US Dollar value up against, say, the Renminbi? I don’t think so. China is currently suffering inflationary pressure, partially because China has tried to keep the value of the Renminbi low against the US Dollar to protect the Chinese manufacturing industry. If US manufacturing is weak, doesn’t it make sense that we would want our US Dollar to fall relative to the stronger economies so that our manufactured goods will be more competitive internationally?

Will a Falling Dollar Lead to a Falling Stock Market? The AOLnews piece quotes a nameless InTheMoneyStocks blogger who insinuates that the stock market will fall if the US Dollar declines. I wish AOLnews wouldn’t assume that an appreciating stock market is the most important indicator of economic strength.

Euro and Yen Exchange Rates, Mar 1, 2011 - May 1, 2011

Figure 1: JPY and EUR vs. USD, Mar 1-May 1, 2011

A simple graph of the S&P 500 index against the Yen exchange rate (Figure 2) shows that the relationship cited between the two is absurd. But even if we accept that the blogger was wrong and that AOLnews was irresponsible in posting this information, we have to wonder whether we really want to measure the health of our economy by the stock market index.

JPY Exchange Rate and S&P500 Index

Figure 2: JPY vs. the USD and the S&P500 (1973-2011)

I used to believe that an appreciating stock market was a sign of economic health but between March of 2009 and March of 2011, the S&P 500 market index has appreciated 72% in real dollars. The national unemployment rate has changed from 8.6% to 8.8% in the same period according to the Bureau of Labor Statistics. This indicates a continuing weakness in the underlying economy in spite of the stock market appreciation.

It does make some sense that demand for US equities will fall if the US Dollar continues to depreciate, but isn’t that only a problem if US companies can’t raise money for expansion? Since US companies are currently sitting on lots of cash,  we don’t need foreign capital to fund investment. Instead, we need a weaker US Dollar so that we will have better opportunities for productive investing of the cash we have on hand. I think we should all hope for the day when an appreciating stock market reflects a strong economy again.

Will a Falling Dollar Lead to Higher Oil Prices? The AOLnews story features an ex-Shell Oil president pointing out that oil exporters will want more dollars for oil if the value of the US Dollar falls. I wish they wouldn’t assume that rising oil prices are uniformly bad for the economy.

Oil is usually traded in US dollars. If the US dollar depreciates, purchasers in countries with a strong currency relative to the US Dollar can now buy oil cheaper. This might make manufacturing cheaper for those countries, which will offset advantages the US might gain from a weaker US Dollar, so it could be bad for the US manufacturers. Oil producers, on the other hand, might find that the dollars they receive buy fewer things on international markets, like tanks to put down the revolutions brewing in their countries, so they will raise the price of oil. The US will see this as an increase in the price of oil.

Hopefully, though, an increasing price of oil will drive investment in the underlying economy to create substitutes for oil. If oil becomes more expensive, microeconomics tells us that new suppliers should enter the market with alternative solutions. If so, and those suppliers are domestic, US manufacturing will strengthen and we will have products to sell to the rest of the world, expecially if that world has been lulled by cheaper oil. Regardless of what you think of oil scarcity, it is clear that the future of oil is higher prices. Innovative substitute technologies will protect us from these problems and make us stronger in the long run.

Like most Americans, I want our economy to strengthen and I want the kind of strength that benefits all Americans. The AOLnews article incensed me because I don’t believe the strength of the dollar reflects the strength of the economy. Exchange rates are there for a reason, so let’s let them do their job. What I do believe is that America should be busy innovating our way to a strong economy. So, I encourage you to do what I do. Turn off the blather and concentrate on the fundamentals. We’ll all be better off for it.

John R. Talbott is lucky to share his name with a much more famous writer who frequently blogs for the Huffington Post. This John R. Talbott received his Bachelors and Masters in Electrical Engineering from Stanford University and has spent much of the last two decades building, marketing and selling high technology in Silicon Valley. He is currently pursuing a Sustainable Management MBA at the Presidio Graduate School.


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