“Dollar rally” has become probably the top news on foreign exchange markets, which can have serious consequences for the US economy (Graph 1, appendix). Stronger dollar is a kind of head wind for American exporters while import from other countries becomes more competitive. Strong currency can theoretically become a stimulus for the Federal Reserve System provoking increase of interest rates. Many companies all over the world borrowed US dollars for investments or development; therefore, dollar strengthening provokes their debts increase. In current situation Central Banks, foreign exchange traders and exporter all over the world keep a close eye on further development of dollar situation. The law of the world market is such that the dollar itself cannot neither increase nor decrease. It means someone takes pains to perform focused actions in order to make the currency stronger. So who will benefit from a stable dollar rate? Who will benefit from gradual increase of dollar versus other foreign currencies and what will be the consequences for American exporters? There are expert opinions that initiators of this situation can be found in America: the government of the country, the top managers of the Federal Reserve System and global corporations playing on stock exchange. If we pay attention to the theoretic background of the problem, we can find the following regularity: if a country exports more than imports or has a negative foreign trade balance, then its national currency should be strong while the exchange rate should be preferably increased versus other currencies (Krugman, 1988). In order to provide competitive ability of the produced goods on the world market it is important to decrease the exchange rate of the national currency or depreciate its rate. What the United States is concerned, American goods export significantly inferior to import. Therefore, to provide the ability to buy goods and services all over the world America has to possess a strong currency (Morgan Stanley Survey, 2014). Exactly this strategy the government of the country and the management of the Federal Reserve is trying to implement. We believe that the market forces should determine the dollar rate as well as the prices for goods and services; however, we understand that market can be to a certain extent irrational. In 1936 Keynes compared the market of financial assets to a beauty contest, the goal of which not to determine who is the most beautiful but to find out, whom others think to be the most beautiful. The goal of operations on foreign exchange market is included in the attempt to predict, what about and how others will think and act. Therefore, the issues of strong dollar affecting export can be given different interpretations. Secretary of US Treasury (Lew, 2014) reported that “strong dollar means strong economy”, while a strong economy increases export possibilities. However, being guided by laws of economy and free market, experts predict decrease of demand for American export goods because the demand curve with high export prices will inevitably fall while strong dollar means exactly high prices for American export goods.
Theoretical Framework of the US Currency Exchange Rates
Paraphrasing Ceteris Paribus assumption “If the price of a good increases, the quantity of it consumed decreases, ceteris paribus”. For example of the price of American cars increases, consumers will buy less of it assuming “that nothing else changes” (Arnold, 2014, p 16). Among other expert opinions explaining the changes in export-import relations with fluctuations of dollar exchange rates, we need to outline the theoretical frame mentioned in works of R. Arnold (2014, p 884). He implements the PPP (purchasing power parity) theory explaining the situation with the US dollar depreciation in case of export price level increase with respect to its influence on other national currencies. For example, an American car priced $20.000 will be approximately 200.000 pesos for a Mexican buyer. However, if the price for that export car will be increased on 10% while dollar depreciates for 10%, that export car will cost $22.000 while the purchasing price for a Mexican buyer will remain 200.000 pesos (Table 1 below).
Arnold (2014, p. 884) implementing the PPP theory states that “changes in the relative price level of two countries will affect the exchange rate in such a way that 1 unit of a country’s currency will continue to buy the same amount of good as it did before the change in the relative price level”. Following Arnold’s PPP theory we may predict that stronger currency will lead to shift in equilibrium in the way that even in case of a stronger dollar it will be depreciated accordingly during exchange rate relations, so that 1 unit of other currency will retain the same purchasing power. However, this theory is being criticized for inconsistency and poor predicting power due to the multiple factors influencing the supply-demand curve rather than just an intercountry inflation rate differences (Taylor & Taylor, 2004, p. 135-158).
US Dollar Appreciation. Another point outlined by Arnold tackles the real interest rate, which explains not only the flow of goods but also the flow of financial capital/assets between the countries with respect to “the invisible market hand”. For instance, European stockholder would want to buy certain financial assets in the US thus increasing the value of the US dollar, which results in supplying more foreign money per 1 unit of US currency. Whereas the supply of foreign currency increases on the market, the exchange rates will provoke the dollar strengthening, i.e. appreciation tendency depreciating the foreign currency, ceteris paribus (the same applies for reverse exchange rates). If we look more closely at the theories presented by R. Arnold (2014), we could see that dollar appreciation can be achieved through a variety of financial instruments on the foreign and stock exchange markets making federal government borrowing more funds, increasing demand for credits pushing up internal interest rates comparing to interest rates in other countries. This tendency will inevitably affects foreign traders’ desire to invest in the US financial assets changing/appreciating the value of dollar, export/import relations and the trade balance provoking budget deficit.
The main question, however, remains, what are the consequences of a stronger/ appreciated dollar on export? Arnold (2014) assumes that an overvalued US currency would affect the demand and supply curve in the way that any other foreign currency becomes undervalued under the terms of fixed exchange rates making American goods and services more expansive for foreigners to buy, negatively influencing the US export possibilities (Graph 2, Appendix). This simple logic implies that the higher are the export prices the weaker is the purchasing possibility of the foreign buyers, thus a strong US currency undermines profitable export and depreciates foreign currencies (Table 2 below).
Arnold (2014) does not deny the fact that the Federal Reserve and the Central Banks of other countries may change the market situation by shifting the equilibrium in the direction of less appreciated dollar by buying foreign currency on foreign exchange market making American export more attractive. These manipulations can increase the demand curve rightward (see Graph 2, Appendix) to the current fixed exchange rate making a foreign currency less depreciated increasing its purchasing power. Certainly, these actions can influence exports in any way, especially if the Central Bank of the foreign country, which is interested in American export goods and services, will also start buying its own currency with the US dollars. These strategies may work efficiently if these manipulations are reciprocal and are not influenced by some force major factors and extra market events (Taylor & Taylor, 2004, p. 135-158).
Strong Dollar VS Strong Economy?
Possibly the most substantial objection against the policy of strong currency can be exactly the fact that such a policy leads to a substitution of concepts “strong dollar-strong economy” (Goldberg & Crockett, 2008). The stronger currency prevents efficient export, while in the circumstance of raising unemployment it may only worsen the situation. From the other side, a stronger currency rate may lead to a lower inflation rate. Therefore, when the major problem in the country is inflation, a strong currency may be a favorable economic fact. The phenomenon of strong dollar demand serious discussions on the market arena, because strong American currency brought the world economy to an anomalous situation, when the richest country of the world is not able to live up to income and has to borrow billions of dollars from foreign countries to finance its tremendous export deficit. The policy of the strong dollar has made a certain impact on internal protectionism, which found its obvious manifestation in new tariffs on US steel import (O'Brien, 2015).
According to financial strategy leader from Wall-Street and the General Manager of Richard Bernstein Advisors, Richard Bernstein (2014) strengthening of American currency will affect export and the overall American economy for a long period of 3-7 years. The tendency of currency strengthening represents a major threat for American corporations oriented on export, which can be compared to the world financial crisis of 2008 (Bernstein, 2014). Competitive possibilities for American economy on the world market are also worsening. For instance, European aviation building giant Airbus Group is expecting substantial profit increase while Boeing will have to switch a cost-cutting regime. Bernstein (2014) supposes that American aviation builder can concentrate its attention on profit saving strategies forgetting about market share increase in the nearest future. According to the National Statistics Survey high dollar exchange rate becomes the drag for development of American export of seafood in January-February 2015. For the first two months of the current year export of seafood from the US on the external markets composed 164 485 tons for 648,7 million dollars. In physical terms, export volumes have decreased on 25 while in in monetary terms on 15% compared to the analogues period of the previous year. American export of salmon composed 15 497 tons decreasing on 24,5% compared to the previous period while in monetary terms salmon sales have decreased on 14,6% to 82,9 million dollars. Similar tendency becomes typical for other product groups.
According to Morgan Stanley Survey (2014), one of the main reasons for strengthening of American currency with respect to majority of world currencies is hiding in anticipated prior charges, denominated in dollars. Bank for International Settlements reported the calculations, which showed that state and corporate dollar claims have achieved record-breaking indicators of 9 trillion dollars, while a substantial part of these claims are expected to be paid in the nearest future. Moreover, in the nearest future the world central banks will also begin to increase the dollar share in own reservoirs. Currently this indicators achieved minimal values of 63% compared to 73% in 2001. In this context, demand for dollar liquidity will logically push American currency to new maximums (Iosebashvili & Zeng, 2015). According to the founder of SLJ Macro Partners Stephen Jen (2014), these factors will provide rise in dollar exchange rate against Euro up to 0.96 dollars for Euro. Continued strengthening of dollar may become a shock for US economy. According to the head of The Federal Reserve Bank of New York William Dudley (2014) is sure that this process with national currency may result in major difficulties of country’s export. More than 65% of American company managers, oriented on export, marked that strengthening of dollar negatively influenced on business resulting in the decision of these companies to decrease capital investments on 25%. The Duke Institute Professor Campbell Harvey thinks that the US appeared to be in the epicenter of horrible competition between the Eurozone, Japan and Canada for the sharpest decrease to dollar. Probably, China will be the next country to switch on to the competition. Such competitive depreciation of currencies may result in substantial profit loss for American exporters in the form of profit and employment decrease.
We consider that the world leading economies have to start thinking more seriously about international economic system, which could recognize a destructive effect of foreign exchange rate fluctuations made by market world’s leading economies on the developing countries. This measure could provide a better stability of the economy on both America and other developed countries with respect to export operations. Concluding we would like to underline that it is better for the US export to support balanced dollar rather than the strong one.
References
Arnold, R. A. (2014). Economics. Published by South-Western Cengage Learning. 11th Edition. California State University, San Marcos.
Goldberg, L. S. & Crockett, K. (2008). The Dollar and U.S. Manufacturing. Current Issues in Economics and Finance. Federal Reserve Bank of New York. Vol 4.
Iosebashvili, I & Zeng, M. (2015). Dollar Watchers Look to IMF. The Wall Street Journal. Retrieved from http://www.wsj.com/articles/dollar-watchers-look-to-imf-1427663175
Keynes, J. M. (2007). The General Theory of Employment, Interest and Money. Palgrave Macmillan. Printed first in 1936.
Krugman. P. (1988). Long-Run Effects of the Strong Dollar. National Bureau of Economic Research. Print.
Morgan Stanley Survey. (2014). The Mixed Blessing Of a Stronger Dollar. ValueWalk Breaking News, Business, Politics, Technology. Retrieved from http://www.valuewalk.com
O'Brien, M. (2015). The Strong Dollar Is the Biggest Threat to the Economic Recovery. The Washington Post. Print.
Taylor, A.M. & Taylor, M.P. (2004). The Purchasing Power Parity Debate. Journal for Economic Perspectives. Volume 18, N 4, pp. 135-158.
Thomson Reuters. (2015). A Stronger Dollar Sparks Second Quarter Earnings Worries For Corporate America. Thompsonreuters.com. Edited by J. Martis.
Appendix
Graph 1. US Export vs US $ Index
Graph 2. Fixed Exchange Rates and an Overvalued Dollar