Friday, 3 June 2011

Crunching the currency

Over at Kiwblog David Farrar writes,
In my Stuff blog, I take a look at the currency, with the record highs against the US and UK. I concluded:
Politically the currency can have a big impact on the economy and the popularity of the government. But it is not something governments can do a lot about in the short term, unless they want to risk billions of dollars in currency speculation. Long-term policies that lead to better productivity can lead to a stronger currency, but in a way which doesn’t harm the export sector so much, as the increased productivity gives them competitive advantage. That is how you get a win-win.
"but in a way which doesn’t harm the export sector"? Will mercantilism not die? I figured that the death blow was delivered to mercantilism back in 1776, but it appears not. Why is Dave, and many others, worried about what happens to exporters? As I have said before Imports good; exports bad:
Why? Well, notice that Adam Smith pointed out more than 240 years ago that "Consumption is the sole end and purpose of all production" and that the measure of a country's true wealth, is the total of its production and commerce. That is, a country's wealth is what the people of that country can consume. The great 19th century French economic pamphleteer Frédéric Bastiat wrote, "Consumption is the end, the final cause, of all economic phenomena, and it is consequently in consumption that their ultimate and definitive justification is to be found." Note also that exports are things that we produce and send to other (overseas) people. That is, they are goods and services that we produce but do not consume and thus they lower our welfare. Imports on the other hand, are goods and services that other counties produce and send to us to increase our consumption. This means imports increase our welfare. So imports are welfare increasing and exports are welfare decreasing. Therefore "imports are good; exports are bad"
Christina Romer has written about the exchange rate recently,
Our exchange rate is just a price — the price of the dollar in terms of other currencies. It is not controlled by anyone. And a high price for the dollar, which is what we mean by a strong dollar, is not always desirable.
Thus a strong dollar is not always a good thing but the same is true of a low dollar. Romer continues - you can replace New Zealand for United States in this,
Such discussions would start with some basic economics. The desire to trade with other countries or invest in them is what gives rise to the market for foreign exchange. You need euros to travel in Spain or to buy a German government bond, so you need a way to exchange currencies.

The supply of dollars to the foreign exchange market comes from Americans who want to buy goods, services or assets from abroad. The demand for dollars comes from foreigners who want to buy from the United States.

Anything that increases the demand for dollars or reduces the supply drives up the dollar’s price. Anything that lowers the demand for dollars or raises the supply causes the dollar to weaken.

Consider two examples. Suppose American entrepreneurs create many products that foreigners want to buy, and start many companies they want to invest in. That will increase the demand for dollars and so cause the dollar’s price to rise. Such innovation will also make Americans want to buy more goods and assets in the United States — and fewer abroad. The supply of dollars to the foreign exchange market will fall, further strengthening the dollar. This example describes very well the conditions of the late 1990s — when the dollar was indeed strong.

Now suppose the United States runs a large budget deficit that causes domestic interest rates to rise. Higher American interest rates make both foreigners and Americans want to buy more American bonds and fewer foreign bonds. Thus the demand for dollars increases and the supply decreases. The price of the dollar will again rise.

[ ... ]

Both developments — brilliant American innovation and troublesome American budget deficits — caused the dollar to strengthen. Yet one is clearly a positive for the American economy, the other a negative. The point is that there is no universal good or bad direction for the dollar to move. The desirability of any shift in the exchange rate depends on why the dollar is moving. (Emphasis added)
So a high/low dollar could be good or bad. It depends on why its high or low. The exchange rate like any price just tells what the relative demand for the dollar is, but it doesn't tell us anything about whether this is a good or bad thing. The question that must be asked is, Why is the dollar "strong" or "weak"? The answer to this question will tell us if we should be worried about the state of the economy. The exchange rate is just a price, at best a signal of the underlying condition of the economy.

A high dollar may harm the export sector, but so what? It helps importers and consumers. Why should we want to help exporters at the expense of importers and consumers? There is nothing inherently good about exporting, so there is nothing inherently good (or bad) about any level of the exchange rate. Just let the exchange rate be will you!


James said...

I think you're right about the export/import story about exchange rates, however there can be other (sub-optimal, general equilibrium) reasons for thinking a given level of the exchange rate is harmful (i.e. welfare reducing). Have a read of . It makes a fairly simple (no math!) New Keynesian case (one that differs from many previous discussions) for exchange rate intervention sometimes.

John Macilree said...

Now for a dumb bush economist's question.

In NZ$ terms the New Zealand economy and my income has been growing weakly but, with the strong rise in the value of the Kiwi, if measured in US$ or UK pounds the recent growth has been impressive. The imports I like to buy, for example books and clothing, seem to be much more reasonably priced. There is also a much greater choice if I shop from overseas on the web.

Am I actually much better off than the NZ$ statistics would have me think?