Does A Strong Dollar Help The U.S. Economy?

While the U.S. stock market is falling sharply — with the Dow Jones industrial average and the S&P 500 hitting lows last seen in 1996 — the U.S. dollar is heading in the opposite direction.

In the past two months, the dollar has risen steadily against currencies from Europe to Japan. American tourists in London are finding that their money goes further than it has at any point in the past six years.

It would be nice to think the rising dollar is a sign that the world thinks Washington is doing a better job than other governments at managing the economic crisis. Maybe it is. But economists have a more down-to-earth reason for the strengthening U.S. currency.

"When people get scared, as they are at the moment, they tend to run for the dollar," says John Williamson, a senior fellow at the Peterson Institute for International Economics in Washington. Like gold, the U.S. dollar has long been a safe haven for investors looking to put their assets in a place where they won't be confiscated or decline sharply in value.

"It may not be as safe as it was," Williamson says, "and I think many people have their worries about the size of the U.S. debt and whether the dollar will always be safe, but certainly it's the safest thing around at the moment."

Plus, there's no practical alternative to the dollar in this situation. No other country has a large enough money supply to accommodate the international demand for a safe-haven currency, nor is there enough gold in the world to take the dollar's place right now.

A Strong Dollar's Effects

But is the popularity of the U.S. dollar good for the U.S. economy? When Treasury Secretary Timothy Geithner was asked that question on CNBC last month, he did not hesitate in answering. "Absolutely," he said. "A strong dollar is in the interests of the United States."

In some ways, though, it isn't. When the Japanese yen declines against the dollar, Toyotas get cheaper compared with U.S. autos, and that's not good for Detroit. Generally, the stronger the U.S. dollar, the bigger the U.S. trade deficit. Williamson scoffs at Geithner's support for a strong dollar.

"Treasury secretaries have always made this rather absurd statement, at least since the mid-1990s," Williamson says. "At that time, there was a good reason for it because the dollar was unusually weak, but they've gone on spouting the same line even when the dollar has been greatly overvalued. I think it's just stupid."

There is another perspective here, however. Between bank bailouts and the massive spending stimulus, the Obama administration is projecting a budget deficit next year of $1.75 trillion. The United States needs to borrow a lot of money — and not just from people in this country. The strength of the U.S. dollar ensures that foreigners are ready to buy U.S. Treasury notes and thereby finance U.S. spending. By comparison, other countries that need a stimulus program will have a harder time borrowing the money they need.

"[The strong dollar] enables us to have more flexibility in terms of fiscal policy and stimulus than most any other country in the world," says David Gordon, until recently the director of policy planning at the U.S. State Department. "It also reflects the continuing view in Asia, and especially China, that the financial stability of the United States and the financial recovery of the United States is crucial to their own economic and financial futures."

Weaker Dollar A Good Thing?

At some point, investor concerns about the United States' growing debt or its trade deficit are likely to mean the U.S. dollar will lose some of its luster. But it probably won't happen as long as the investors are worried about the world economy. Gordon, now director of global markets research at the Eurasia Group in Washington, says in this sense a dollar turnaround is something to hope for.

"Part of the reason that the dollar is so strong is that fear is dominating global markets," he says. "When there's a recovery, when trade begins to pick up, one of the first signals of that recovery, ironically, is going to be a relative weakening of the dollar."

The stock market goes down, the dollar goes up. And when the dollar goes down, don't be surprised to see the markets going up.

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