Here in the U.S., we are pretty lucky. We transact all of our business in dollars, and it never occurs to most of us to think about other currencies until we travel outside the U.S. It just doesn’t enter into our consciousness that we should care, or need to care, about the dollar itself. Like air, we take it for granted.
But, like air, when things turn bad, we have to start paying attention pretty quickly. Again, here in the U.S. we have never really had to cope much with that problem. As the “reserve currency,” the U.S. dollar is the currency for most of world trade, and therefore everyone else has to hold dollars in one form or another if they want to trade with the U.S.—and they do. We have a built-in demand for our currency that supports its value. The benefit is that we can buy things made in other countries cheaper, in dollar terms, if the dollar is strong.
The flip side, of course, is that, if the dollar is strong, it is more expensive for other countries to buy things from us when the cost is expressed in their own currencies. For a Japanese buyer of a Ford, for example, if it takes more yen to buy a dollar, then to buy a Ford—the cost of which is expressed in dollars—will also require more yen. Conversely, if a dollar buys more yen, it will be cheaper for a U.S. consumer to buy a Toyota, built in Japan, which is priced in yen. You can see why exporters prefer to have a cheaper currency, as it makes it easier for foreigners to afford their goods.
Which brings us to the present. In our discussion of gross domestic product (GDP) the other day, we discussed how one area of growth is to export more than you import. Per the discussion above, having a weak currency can help you do exactly that. Not only does a weak currency help foreigners afford your goods, it also makes foreign goods more expensive for your own population, thus discouraging imports. This is one of the foundations on which first Japan, then Korea, and now China have built their manufacturing bases. By keeping their currencies cheap, they help ensure that their manufacturers can export at very competitive prices and their populations cannot afford much in the way of imports.
That was fine when everyone was growing, and the U.S., as the largest importer, was happy to support that export-led growth for a variety of our own reasons. During the 1950s and 1960s, and then the 1990s and 2000s, free trade benefited everyone. If you own a big-screen TV or a car, you are a direct beneficiary of free trade. Free trade led to lower costs for everyone.
But the problem now is that growth is much harder to come by, and a dog fight is developing over every possible source of growth. Whereas growth driven by consumer and business demand led the U.S. economy for the past couple decades, export-led growth will now be more important in both a relative and absolute sense. We can’t afford to give away an export advantage in the form of currency mispricing relative to our trade partners.
The further problem is that every other country in the world is pretty much in the same position. Every country is looking for growth in all areas, and every country is looking to grow exports. Every country is also looking to devalue currency to help that export growth.
But not every country can successfully devalue at the same time. If every country is devaluing, some country’s currency has to be appreciating. Historically, that has been the U.S. currency, but that doesn’t look to be sustainable this time around.
One problem that is exercising Europe’s governments is the strength of the euro, which they perceive is holding back their recovery. Japan has just made an explicit commitment to weakening the yen, and China has a long-standing commitment to keep the yuan at cheaper levels than the market might suggest. And the U.S., although not explicitly saying so, has, as a side effect of the various quantitative easing programs, set out on a course of action that should probably result in a weaker dollar.
Not everyone can win this game, and, with the stakes so high, the losers will be forced to take more aggressive measures. The phrase “currency war” is showing up more and more often in the press, as well as in books and academia. This is a metaphor, but, even so, we will certainly see conflict, and the effects on not only the currencies but also general trade patterns could be substantial.
The U.S. is relatively well positioned for this type of conflict. We have the reserve currency, and a relatively small part of our economy is dependent on exports. We would also benefit significantly from a strong currency in the form of cheaper imports—of which oil would be the most significant. Nevertheless, despite that relatively strong position, the damage could be substantial.