The Independent Market Observer

Is the U.S. Losing the Currency Wars?

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Mar 27, 2015 1:36:00 PM

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currency warsPlenty of people are concerned about the “currency wars” now playing out around the world. As you might guess from the quotes, I don’t entirely agree with the notion that we’re at war—and I’m even less convinced that the consequences would be as extreme as that kind of language implies.

The trouble with currency valuations

First off, it’s notoriously difficult to predict what currency values should be, much less how they will change over time. As an example, many doomsayers were, until quite recently, calling for the collapse of the dollar. That call has been incorrect in a very big way.

One simple tool for comparing currency values is The Economist’s “Big Mac index.” The idea is that the cost of a Big Mac should be almost identical, country to country, so the relative prices provide a guide as to a reasonable currency valuation ratio. It’s never that easy, of course. Even with a metric this straightforward, we see many currencies at “incorrect” values for years at a time.

There really is no one right value for exchange rates.

How currency wars work (in theory)

Given this uncertainty, it doesn’t seem unreasonable to wonder if countries might try to manipulate their currencies to gain an economic advantage. A central bank (such as the European Central Bank, the Bank of Japan, etc.) that acts to increase the supply of a currency also depresses the value of that currency. It’s simple supply and demand: the greater the supply of a currency, given constant demand, the lower the price.

A lower price for a currency, then, would indeed give an advantage to the exporters in that currency. When the yen gets cheaper against the euro, say, Lexus can sell a car at a discount in dollars and still get the same amount of yen. That puts Mercedes, or Ford, at a competitive disadvantage. In principle, the idea of currency wars might make sense.

This scenario is, in fact, what we now see playing out around the world, especially here in the U.S. With other currencies weakening against the dollar, foreign manufacturers have a sales advantage against American companies. In many ways, this is the poster case for a currency war, with predatory foreign governments cheapening their currency to steal American jobs and profits.

Drawbacks for U.S. companies, benefits for consumers

I wouldn’t say the U.S. is losing the currency wars, however. Looking at the bigger picture, we also have to consider how a strong dollar affects American consumers. One of the supporting factors for cheaper oil and other raw materials, including food, has been the strong dollar. Anything that Americans import—cars, TVs, clothing—a strong dollar makes cheaper.

There are negative effects of a strong dollar, of course, but a weak dollar makes everything more expensive. Last time I checked, that was bad for the economy. In fact, many of those most worried about currency wars are also worried about inflation.

Much of the historical angst related to currency wars comes from the gold standard era. At that time, there were solid economic reasons to both wage and fear currency wars. Now, in a fiat money world, the effects are smaller, more indirect, and much less damaging. 

My two cents

You might argue that things could get worse, and that is always the case. The current actions of foreign central banks do have negative effects. But while a stronger dollar will continue to be a headwind for U.S. companies, it will also benefit the U.S. consumer.

We’ve had a much stronger dollar in the past than we do now, and we’ve done well with it. I take the current disaster warnings regarding dollar strength in the same way I took the calls for economic disaster due to dollar weakness. This, too, will pass.

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