The Not-So-Almighty Dollar

There’s no reason for all the hand-wringing about the strong greenback
Photo Illustration: Dorothy Gambrell

The dollar is pennies away from being equal to €1 for the first time since 2002. U.S. manufacturers fret that the stronger currency will kill their sales. Yet American policymakers seem blasé. Secretary of the Treasury Jacob Lew says a strong dollar is in America’s interest, and Federal Reserve Chair Janet Yellen, at her March 18 press conference, said it “reflects the strength of the U.S. economy.”

Why aren’t U.S. officials complaining about being on the wrong end of a currency war? Two reasons. First, the dollar’s rise is primarily the result of market forces and ordinary monetary policy, not market manipulation. Second is that—surprise!—the dollar hasn’t actually risen much, all things considered. “The perception of the dollar’s rise tends to be overstated,” says William Cline, a senior fellow at the Peterson Institute for International Economics in Washington. He’s a veteran of currency turmoil; he worked for the Department of the Treasury for two years starting in September 1971, a month after President Richard Nixon roiled the foreign exchange markets by suspending the convertibility of dollars to gold. The “Nixon Shock” caused the dollar to fall against gold and other currencies, angering trading partners.


It’s true that over the past year the dollar has risen 29 percent against the euro, which was worth $1.08 as of March 18, but it’s gone up considerably less against some other important currencies, such as the Chinese yuan. The right way to judge the dollar’s value is to look over a long period, consider all of the countries the U.S. trades with rather than cherry-picking one or two, and take inflation into account. The Federal Reserve’s broad, inflation-adjusted dollar index, which dates to 1973, does all of those things. It shows that while the dollar is indeed up 15 percent from its 2011 low, it’s still 17 percent lower than it was in early 2002. And it remains 27 percent lower than it was in March 1985, when the dollar’s extreme overvaluation was killing U.S. manufacturers. “It’s not a catastrophic shock,” says Charles Collyns, chief economist for the Institute of International Finance in Washington and a former Treasury official.

If the dollar did get too strong, it would raise unemployment in the U.S. by hurting production. Exports would fall because they’d become too expensive for foreign buyers, and imports would rise because foreign-made goods would suddenly be cheaper. A currency war is what happens when countries try to push their currencies down to generate jobs at home, palming off their unemployment problem on trading partners. The term of art is “beggar thy neighbor.”

American policymakers aren’t crying about the dollar’s rise because it’s mostly a reaction to a good thing: relatively strong economic growth in the U.S. The demand for dollars has risen as the world’s investors put their money into stocks and other U.S. assets that benefit from growth and rising profits. Likewise, the euro is sinking because investors have less faith in the ability of euro zone governments to lift their economies’ growth rates.

True, the European Central Bank is exacerbating the euro’s weakness through its new program of buying bonds to lower interest rates. Low rates, while primarily intended to boost borrowing and spending at home, have the side effect of making the euro decline in value, giving European nations an advantage in international trade.

But this bond-buying isn’t tantamount to currency war. After all, Americans never felt they were fighting a currency war when the Federal Reserve bought more than $3 trillion worth of Treasuries and mortgage bonds. (Although former Brazilian Finance Minister Guido Mantega did accuse the Fed of trying to devalue the dollar to gain an edge in trade.)

The test for whether a country is launching a currency war is whether it’s pushing down a currency that ought to be rising—for example, by buying lots of another nation’s currency with its own. Generally speaking, countries with big trade surpluses should have rising currencies, and ones with big trade deficits should have falling currencies. A surplus or deficit in the current account—the broadest measure of trade and investment income—that’s bigger than 3 percent of gross domestic product is a sign that things are out of whack, says the Peterson Institute’s Cline. The U.S. and euro zone balances are both safely below that threshold, indicating that their exchange rates aren’t far off fair value, he says.

China’s government engaged in currency warfare for years by suppressing its currency despite a massive trade surplus. Lately, though, even China has stopped. The yuan is little changed over the past year, and the country’s current account surplus with the rest of the world has shrunk to about 2 percent of GDP, from 10 percent in 2007, according to an International Monetary Fund tally.

If Yellen and her fellow Fed rate-setters did conclude that the dollar’s strength was doing serious damage to the economy, they could try to counteract its depressive effect by restarting bond purchases to bring down long-term interest rates. They aren’t doing that. In fact, on March 18 they affirmed that they could begin to raise the federal funds rate as early as June if conditions warrant—a sign of cautious confidence in the U.S. economy’s resilience.

All bets are off if the dollar keeps rising. Unfortunately, history shows that when traders start bidding the dollar up, they don’t quit until they’ve overdone it. “If this dollar bull market is going to be in line with the magnitude of the two previous bull markets [peaking in 1985 and 2000], the euro will test the record lows set in 2000 around 82 cents,” currency analyst Marc Chandler wrote on his blog, Marc to Market, on March 11. That big a gain, especially if matched by strength against the pound, the yen, and other important currencies, really would be a problem for the U.S. economy.

—With Rich Miller

The bottom line: The dollar’s rise against a range of currencies is not nearly so strong as the greenback’s ascent in 1985 and 2000.

    Before it's here, it's on the Bloomberg Terminal.