Oct 23 2007

The US dollar’s decline in value may cause more harm than good for the US economy

Asia Sentinel – A Falling Dollar Does Nobody Any Good

Many economists hail the decline in value of the US dollar as a boon to the American economy. It may sound counter-intuitive, but economic theory predicts that when a currency depreciates relative to other currencies, this could actually be good for the country’s economy? Why, you ask? Let’s consider an example:

In the last four months the value of a dollar in terms of euros has gone from 0.75 Euro cents to 0.69 Euro cents. For Europeans, that means that dollars are cheaper now than they were four months ago, therefore American goods are cheaper now than four months ago. Cheaper American products should mean more business for American companies as Europeans demand more of their stuff. Good for business, right? In the US, aggregate demand will shift out, unemployment should fall, and the price level should rise as more foreigners demand more American products. But what impact does the weaker dollar have on Americans?

What’s the impact of the falling dollar on American consumers? Let’s look at the situation from their perspective. To Americans, while their dollars have gotten cheaper, the euro has gotten more expensive. Since June one euro has gone from costing Americans $1.32 to 1.43 today. In other words, one euro’s worth of European made products has gotten that much more expensive for American consumers. The higher prices of imports from Europe combine with the higher prices of products made in the United States that resulted from greater European demand for American products to drive the American price level higher still. Inflation is a serious concern as a nation’s currency depreciates against those of its trading partners.

Besides the immediate impact on the balance of trade between America and its trading partners, there are several less obvious outcomes of a weaker dollar. As discussed in the article, these include:

Rising living standards overseas:

“The collapse of the dollar would be great for Asian consumers, who would see sharp rises in their standards of living as their wages and savings gain purchasing power, while American workers and landlords see a corresponding decline in the real values of their pay and rent.”

Increasing costs for American manufacturers:

“Too often overlooked is how the weakening dollar also works to increase costs for US manufacturers. A falling dollar raises the costs of raw materials such as oil and metals, while simultaneously decreasing the relative costs that foreign competitors pay for the same supplies.”

Higher prices of foreign made components used in American factories:

“Perhaps even more important will be the prices of foreign-made components used in American factories… as the dollar loses value, the costs of importing all of the components will rise, making the finished product more expensive for Americans.”

Higher interest rates in the US:

“Because a falling dollar diminishes the global appeal of dollar-denominated debt, U.S. interest rates will inevitably rise, resulting in increasing capital costs for domestic manufacturers.”

Higher nominal wages and rents in the US (resulting in firms moving more jobs overseas where wages and rents are lower):

“…as a weaker dollar forces up domestic consumer prices, American workers, suffering from declining real incomes, will ultimately press their employers for more generous pay raises… Similarly, landlords will look to raise rents to make up for the falling purchasing power of their rental income.”

Less tax revenue, potentially greater budget deficits and debt (or higher taxes on Americans):

“…as rising interest rates and consumer prices combine to exacerbate the severity of the coming recession, federal tax receipts will inevitably decline, causing the budget deficit to swell anew.”

This article served as a wake-up call to me personally, who, like many economists, tend to think in terms of ceteris paribus, or all things equal… In the case of a weakening dollar, it’s easy to look at the immediate impact on the US balance of trade, which by all accounts has been skewed unfavorably against American firms for decades, as growth in imports from the rest of the world have far outpaced growth in exports to the rest of the world. A weaker dollar may help achieve a more balanced current account between America and its trading partners, but at what cost to American consumers and, potentially, its producers as well?

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About the author:  Jason Welker teaches International Baccalaureate and Advanced Placement Economics at Zurich International School in Switzerland. In addition to publishing various online resources for economics students and teachers, Jason developed the online version of the Economics course for the IB and is has authored two Economics textbooks: Pearson Baccalaureate’s Economics for the IB Diploma and REA’s AP Macroeconomics Crash Course. Jason is a native of the Pacific Northwest of the United States, and is a passionate adventurer, who considers himself a skier / mountain biker who teaches Economics in his free time. He and his wife keep a ski chalet in the mountains of Northern Idaho, which now that they live in the Swiss Alps gets far too little use. Read more posts by this author

22 responses so far

22 Responses to “The US dollar’s decline in value may cause more harm than good for the US economy”

  1. Margaret Liuon 25 Oct 2007 at 9:29 pm

    Wait, so would we in China be profiting by this? Or does it all depend on what most of our currency is based on (RMB or USD)? Inflation in a country is good for the rest of the world but not for that country…what a trade off. Americans would also have a hard time buying their own products since production cost increases and higher demands from other countries are making a double drive in forcing prices up.

  2. Alice Suon 25 Oct 2007 at 10:27 pm

    It's interesting how one single factor- declining value of American currency- can lead to soo many effects in not only the American economy, but in that of the whole world. It may be true that the USD's decline in value will lead to a better balance in trade as US exports more; however, the increased cost and loss that this inflicts on the U.S. economy is definitely not worth it.

  3. judychenon 25 Oct 2007 at 11:38 pm

    I have read an article about the decline of USD before, and it even said the value of USD won't go up soon in the future. I think the USD's decline in value really hurts America since USD has always been people's preferring currency to deposit.

  4. timothysunon 26 Oct 2007 at 1:28 am

    I always had an idea from this. I was wondering if, since for example, Person A's salary was in USD, that he deposited it all into RMB, and when the USD was at its minimum, the person switches to USD. Then, he would make some money. But I think the banks probably have outsmarted me already, by adjusting this.

    I find that the war in Iraq is much to blame, though, for this inflation.

    At least we're not in the situation of Hungary post-WWII.

  5. Conrad Liuon 26 Oct 2007 at 2:53 am

    Yeah, it's kinda scary how, like many others said, one change in value in one type of currency like the U.S. dollar can have a huge impact on many other affairs of economics. I'm sure there are more exploitations that people will be using if the USD really starts to depreciate in value.

  6. Charlie.Gaoon 26 Oct 2007 at 8:37 pm

    my parents were talking about how the dollar was slowly declining and how that sucks because my parents get paid with usd rather than rmb, and once u convert the usd into rmb, you get less than what you would have gotten a year ago.

    and although there will be a more balanced trade, i predict that unemployment in america will slowly begin to rise and that really isnt a fair tradeoff.

  7. kevin maon 27 Oct 2007 at 11:52 am

    Like everyone said, the USD losing its value will lead to a more balanced in trade. However, it will affect the American citizens greatly. As the USD loses its value, the american citizens are getting poorer.

    I agree with Charlie that it is not a good tradeoff. I think it is safer to have a fixed value for your currency like China.

  8. Chris Seahon 27 Oct 2007 at 7:00 pm

    This is interesting. It is true that a depreciation of the U.S. dollar versus the Euro bodes well for American industry in Europe. However, WITHIN the US itself, foreign products would become more expensive due to the new exchange rate! While residents of Europe enjoy lower-priced American-made cars or iPods, for example, Americans would be subject to higher prices on foreign cars, which constitute a large part of the U.S.'s auto industry.

    Long story short: Weak US dollar = Good for world that likes to buy American goods… Bad for Americans who want foreign goods. Nyaah.

  9. Trevor Sunon 28 Oct 2007 at 2:40 pm

    That really sucks for American citizens who now face higher prices but I guess they had it coming ever since they went into Afghanistan. All those years of spending gone into the war effort in Afghanistan and Iraq and what do they have to show? Didn't find any weapons and Iraq's future is looking grim. But at least other countries are benefiting from this, and after all those years the Canadian dollar is worth more. booya

  10. HowardJingon 28 Oct 2007 at 9:07 pm

    I guess now would be a good time for Americans to invest in the Euro before the price disparity increases even more, and sell their investments when the Euro becomes even higher than it is now.

  11. Melanieon 28 Oct 2007 at 10:17 pm

    it is amazing how the decline of the American Dollar can affect so many other countries. Well i suppose it was "America's Century". American consumers are on the losing end though, as compared to many asian countries, America is incredibly expensive. With prices and inflation on the rise, would the majority of the U.S population become poorer?

  12. Calebon 28 Oct 2007 at 10:58 pm

    The decline of the dollar is definately a bad thing. America has long since started outsourcing many of their jobs overseas and in general has a service based economy. More harm is done to Americans by weakening the dollar because the outsourced jobs are now costing firms more and more money, and that causes an inflation of prices in their goods, or it causes layoffs and mass unemployment within the U.S. even more so than the unemployment caused by imballanced exports to imports.

  13. Philip Trampeon 29 Oct 2007 at 10:21 am

    I think its really interesting to see how much the American dollar actually effects the rest of the world. It really puts into perspective how big an impact a superpower like the USA has on the economies of the other countries of the world. i guess its good for us out here in China though who want to buy our goods from the states however it's not really something for the Americans to cheer about if they plan on buying foreign goods.

  14. Hansen Guon 29 Oct 2007 at 6:31 pm

    It is interesting to read the first quote there about Asian living standards. For us living in Shanghai, whose parents are paid in RMB, it's a good thing. However, come winter break and some of us return home to the States, we might see the repercussions. And yes Philip I agree, it is interesting to see how the American dollar affects so many countries and aspects of life.

  15. Jeff Yeon 29 Oct 2007 at 7:41 pm

    I was surprised a while back when i found out that 1 USD was worth less than 8 RMB. This initially made me a little happier because you could get more USD with your RMB, and it was especially beneficial because i went back to the U.S. last summer. However, i didn't think about the reprecussions on American economy, and how prices of imported goods would rise. I probably won't enjoy this change when i go back there for college.

  16. jenniferchoion 29 Oct 2007 at 11:21 pm

    It is intresting to know that a weaker dollar may help achieve a more balanced current account between America and its trading partners. But for people living in America, the decline of USD value is a bad thing, as Caleb said. And it is really interesting to see how change in the value of USD affects us, poeple living in Shanghai,China, and the people living in all around the world.

  17. GDuboison 03 Nov 2009 at 1:53 am

    I commented on another blog post just recently where I expressed how the recession and a weaker dollar may benefit the US, so I thought this post would be interesting to peruse and see what the opposing arguments are.

    I would agree with your last comments about the current account balance which would be affected by the USD decline in value. I think, however, it is the duration of such an improvement that would be questionable. Correcting a current account surplus or deficit involves a see-saw motion of over and under shooting the optimal equilibrium. It is to hope, yet, that this will at least bring the US balance closer to those of foreign economies.

  18. Virginiaon 17 Nov 2009 at 12:25 am

    I thought that this article was interesting, because it gave a counter argument to the ceteris paribus. I can understand that for the Europeans it is a benefit if the USD is weaker, because now they can buy more. However, as mentioned in the article there is no benefit for the US individual. Furthermore, this article shows how important the USD is, and how it doesn't only effect the Euro and the Dollar, but it affects all other currencies around the world and the people not having anything to do with the currency.

  19. A.Eon 17 Nov 2009 at 6:57 pm

    The American society would not benefit from the weak dollar. When US manufacturers have higher costs, then they would have to be forced to increase the price on their products in order to be able to pay of their debts. This would cause less demand for their products. The American households would be forced to buy higher prices for their products and their rest income would decrease. In addition, when they have higher rents then their remaining income decreases even further. This would cause the whole society of America to decrease regarding their living standards. If Americas wealthfare decreases, then there production and manufactoring would also be harmed. If production would decrease, then there exports would decrease. The trade with other nations would therefore, decrease and America income would once again decrease. Also the other nations would be harmed as they could no longer have good products from America.

  20. Laura Gon 18 Nov 2009 at 6:40 pm

    I think that the American society not only benefits from the low prices. The American companys will have higher costs with the depreciation of the dollar, and therefore they will have to increase the price in the long-term. This will only mean higher prices for Americans, and they would rather buy foreign products that are cheaper (for example from China). In the long-run American companys might not be able to make as much profits as they need to pay off the costs. This could mean that the industries will collapse and depend more on subsidies in the future. For Americans this is not better either, as the households will need to pay higher prices for many products, and the total income per month will decrease.

    Although it is good for China, as they export large sums to the US, it is not cheerable for the Americans. This could cause trouble in the future, and more people will have trouble buying products for the same money amount.

    I think this article was very interesting, and gave a good perspective of the USdollar and the effect on different currencies. Not only is China,the Euro, and the US dollar hurt, but all currencies are affected in the long-run and it is a negative effect to all countries that have a trading relationship with China, and the US.

  21. Oli and Kevinon 19 Apr 2010 at 6:11 pm

    EU perspective:

    Weaker $ => cheaper $ for EU => increase business for American companies=> AD shift out => decrease unemployment => Pl rise

    US perspective:

    Weaker $ => EU has gotten more expensive => higher Price of imports => greater European demand for US good => ever growing PL => inflation

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