In early 2008, before we knew officially that we were in a recession, before the greatest part of the upheaval in financial markets, and before Americans’ balance sheets deteriorated with the worst of the housing crisis, the U.S. dollar reversed a long-term decline and actually began to appreciate against foreign currencies. In retrospect, the 20 percent appreciation of the dollar from March 2008 to March 2009 was a “safe haven” event.
Investors around the world, seeking the least risky investments they could find, increasingly chose U.S. assets, especially U.S. government bonds, and thus, the dollar rose.
That’s over now. Since March of this year, the dollar has given up almost all of its gains and is nearly back to its March 2008 levels. Predictably, we’re now hearing warnings from some about the decline of the dollar. In truth, this decline has been going on since 2002 (some might even say since 1973). As most enterprises that export know, this can actually be a good thing for business and jobs.
That’s increasingly true for Indiana, where exports have been growing in importance for the state economy. Nationally since 2000, the percentage of our economy devoted to exports of goods has gone from eight to nine percent. For Indiana, this ratio has risen from 7.9 to 10.4 percent. In terms of how important the global economy is to our state economy, we’ve gone from slightly below average to above average in just eight years.
Many Hoosiers probably already knew this because many of them have jobs that are increasingly tied to exports. For them, the run up in the dollar during the worst of the financial crisis was exactly the wrong medicine at the wrong time. Since March that has changed and a depreciating currency has been good medicine for a recovering economy.
But, what does the future hold? With a state economy in which exports are increasingly important, will goods produced here continue to get cheaper for foreign customers or will the dollar regain strength and make our goods more expensive for our customers in Canada, Europe, and perhaps even China?
A very long view of the dollar’s value against foreign currencies reveals what economists refer to as a secular decline: aside from two notable interruptions in the mid-1980s and late-1990s, the dollar’s trend has been downward since the 1970s. Overall, the decline over that period has been about 25 percent. Predicting the immediate future path of exchange rates is a fool’s game – if foreign central banks want to stop the dollar’s decline in order to keep their own exports competitively priced, history tells us they could do so. But history also suggests that their success at doing so will be short-lived and that the secular decline of the dollar is likely to continue.
There are great forces at work on the dollar. The two most important of these forces are linked – international imbalances and our own fiscal housekeeping. For many years now, the U.S. has been the world’s busiest shopper, eagerly buying up much of the rest of the world’s excess production. Additionally, our low savings rates and federal government deficits have necessitated the borrowing of funds from abroad to finance our consumption and investment. Thus we’ve run trade deficits while the rest of the world has been running trade surpluses. There are intense debates among economists about the sustainability of this arrangement, but many (and I count myself in this camp) think it cannot last.
To reverse this arrangement, a number of things would have to happen. Generally, our goods have to become cheaper for foreigners and their goods have to become more expensive for us. A depreciating dollar accomplishes this, and there are some important forces at work that seem to be putting downward pressure on the dollar. As economies around the world improve, central banks will begin removing the monetary stimulus that they have been providing since last fall. In the near term, however, most scenarios have the U.S. Federal Reserve waiting longer than other central banks to begin raising interest rates. This would keep our interest rates low relative to the rest of the world, contributing to continued downward pressure on the dollar as investors worldwide seek the highest returns on their investments. In the longer term, a decreasing foreign appetite for U.S. assets may shrink demand for dollars, thus placing additional downward pressure on the dollar.
The sand in the gears of this mechanism is China’s currency policy. China has held its currency fixed against the dollar since the worst of the financial crisis began in the late summer of 2008, effectively preventing a more significant decline in the dollar. Few realize, however, that in the three years prior to that, China actually allowed its currency to appreciate against the dollar in a typically Chinese way – very slowly and methodically. From the summer of 2005 to the summer of 2008, the Chinese Renminbi actually appreciated by 17 percent against the dollar. If China were to resume that policy, that would be another factor contributing to the long-term downward trend of the U.S. trade-weighted exchange rate.
In my view, this is not something we should fear. Sure, those of us who like to travel abroad will find that our trips are becoming more expensive. However, those folks in other countries who buy our goods will find the price is increasingly right. It’s no coincidence that schools like my own (Rose-Hulman Institute of Technology) are increasingly seeing an influx of foreign students. They are here purchasing one of our top service exports – higher education. That too is an important part of the Indiana economy that is helped, not hurt, by a falling exchange rate.
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