Yes, the Falling Dollar is a Problem
In “Falling Dollar Phobia,” Paul Krugman writes:
And why, exactly, should we regard dollar decline as a problem? It helps exports — and export booms are the normal way countries emerge from financial crisis. Dollar declines haven’t brought woe in their wake in the past: neither the huge decline after 1985 nor the sustained decline during the Bush years — both of them dwarfing anything we’ve seen recently — brought catastrophe; in fact, both were associated with OK economic growth and mild inflation.
Previously I wrote about how we shouldn’t worry about hyperinflation because of the Fed’s decision to keep interest rates low at just .25% for over 2 years. However, this still doesn’t mean that the dollar’s slow but sure depreciation isn’t a problem that needs to be dealt with. Below is a graph I took from the St.Louis Federal Reserve database of economics indicators; it displays a time series of the trade weighted exchange rate index between the U.S. Dollar and the currencies of the U.S.’s major trading partners.
As you can roughly see, the dollar really hit its absolute maximum during March of 2002. Then it took a precipitous fall until midway of the current recession, where it appreciated to a local maximum (though nowhere near where it was originally at its peak) and then continued to fall. Because the dollar has been falling for almost the last decade I’m going to go ahead and say that the dollar’s depreciation is not transitory, but rather chronic.
Krugman is a fucking idiot. If this dollar depreciation continues there will be more frequent commodity bubbles (like we’re having now, especially with oil), higher input costs for American manufacturers, and the erosion of the average American’s purchasing power parity. I highly doubt that the decline in the dollar’s exchange rate will lead to any sustainable export boom as Krugman suggested. In order for the exchange rate to matter enough for us to become an export economy is for the dollar to be so worthless that Americans are forced to significantly lower their standards of living and U.S. businesses are willing to stop outsourcing certain manufacturing production chains. I’m not sure why that’s good. In the end, it just punishes the American consumer.
However fucked up the decline of the American currency is, there may be nothing we can do about it. Its decline probably has to do with the web of intricacies that constitute the economic performance and growth of this country. As Felix Salmon points out:
US workers are massively overpaid compared to their equally-productive and well-educated counterparts in countries all over the world. There are a number of ways that the discrepancy can be narrowed: wages in countries from Slovenia to South Africa could go up; US wages can go down; or the dollar can simply depreciate. Which is a lot easier than nominal or even real wage cuts.
None of this is under the control of the Treasury Secretary or anybody else, no matter how often he repeats that a strong dollar is in the national interest. And the clear implication is that the dollar is going to continue to weaken for the foreseeable future. That’s not going to do much if any harm to the US economy. But it does add a certain amount of fuel to commodity-bubble fires.
Epic Inflections 
I won’t comment on the dollar decline, but I question your “falling dollar causing a commodity bubble” thesis. A bubble is something that will burst and I do not see commodity prices bursting anytime sooon. Yes, commodities will be more expensive to the U.S. because of a weakening dollar,. but that does not define a bubble. Corrections will be inevitable, but the floor on most commodities has definitely been moved up significantly. ANd why should this not be so. When you have two countries that make up 37% of the world’s population and are growing GDP at close to 10% a year, what you have is an unsustainable rate of cpompounding. As long as those growth rates remain, commodities will remain in a secualr bull market and recover quickly from each correction. China has a voracious appetite for commodites at present. When you add the rest of Asia you wind up with 60% of the world’s population. And remember this is with China’s one child policy. It seems only common sense that this is a paradigm shift in global economics and pricing for commodities. See
https://www.gmo.com/America/CMSAttachmentDownload.aspx? target=JUBRxi51IICi3XDk3kgSh6vLtzbPwJWv9j9b13l0dYjF9rvqA%2bOemQJnKCUtBlLDDT%2fh8Vj%2fLziezC4nF7YfHbgtGQ%2bonQI1B9fB4K%2fEAsE%3d
Alpha
May 4, 2011 at 6:47 pm
Hey Alpha! Thanks for your comment.
What I was suggesting was that a falling dollar will result in a greater frequency of commodity bubbles. The Fed does a create a certain uncertainty for the valuation of the dollar by the market. Every time there is a recession the Fed drops the rate to a degree no one is sure of and for a time period that investors can only speculate. This almost always results in a class theory of malinvestments bubble. Long term, I do see the dollar continuing a slow steady decline with short bursts of appreciations from time to time, though never fully recovering value.
From what I understand, you’re saying that the prices of commodities reflect actual demand and is not a bubble. And yeah, I agree that the floor for commodity prices has certainly moved up over time. To me, that rising floor after a bubble bursts represents natural inflation. However, I don’t see the rapid pace of growth over the last few months as justified by demand-supply fundamentals.
As for India and China, I agree they are growing very rapidly and have a huge appetite for raw materials. Though, I very much do think that their current and short term demand for commodities does not justify the rapid rise in prices. Their potential is for long term growth. At the moment, their present per capita incomes, consumption expenditures, and maturity of their capital markets, keep me from greatly valuing them in the short term. They are also, in my opinion, far from decoupled from the economies of the U.S. and the E.U.
Mike P.F.
May 4, 2011 at 9:33 pm