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Currency Revaluation Won't Fix America's Trade Mess

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It is sometimes suggested that our trade problems (job losses, international indebtedness) will go away on their own once currency values adjust. Bottom line? A declining dollar will eventually solve everything.

In the short and medium term, of course, foreign currency manipulation will prevent currency values from adjusting. But even if we assume currencies will eventually adjust, there are still serious problems with just letting the dollar slide until our trade balances.

For one thing, our trade might balance only after the dollar has declined so much that America's per capita GDP is lower, at prevailing exchange rates, than Portugal's. A 50 percent decline in the dollar from early-2011 levels would bring us to this level. And how big a decline would be needed to balance our trade nobody really knows, especially as we cannot predict how aggressively our trading partners will try to employ subsidies, tariffs, and nontariff barriers to protect their trade surpluses.

Dollar decline will write down the value of wealth that Americans have toiled for decades to acquire. Ordinary Americans may not care about the internationally denominated value of their money per se, but they will experience dollar decline as a wave of inflation in the price of imported goods. Everything from blue jeans to home heating oil will go up, with a ripple effect on the prices of domestically produced goods.

A declining dollar may even worsen our trade deficit in the short run, as it will increase the dollar price of many articles we no longer have any choice but to import, foreign competition having wiped out all domestic suppliers of items as prosaic as fabric suitcases and as sophisticated as the epoxy cresol novolac resins used in computer chips. (Of the billion or so cellular phones made worldwide in 2008, not one was made in the U.S.) Ominously, the specialized skills base in the U.S. has been so depleted in some industries that even when corporations do want to move production back, they cannot do so at feasible cost.

Another problem with relying on dollar decline to square our books is that this won't just make American exports more attractive. It will also make foreign purchases of American assets--everything from Miami apartments to corporate takeovers--more attractive, too. As a result, it may just stimulate asset purchases if not combined with policies designed to promote the export of actual goods.

A spate of corporate acquisitions by Japanese companies was, in fact, one of the major unintended consequences of a previous currency-rebalancing effort: the 1985 Plaza Accord to increase the value of the Japanese Yen, which carries important lessons for today. Combined with some stimulation of Japan's then-recessionary economy, it was supposed to produce a surge in Japanese demand for American exports and rectify our deficit with Japan, then the crux of our trade problems. For a few years, it appeared to work: the dollar fell by half against the yen by 1988 and after a lag, our deficit with Japan fell by roughly half, too, bottoming out in the recession year of 1991. This was enough for political agitation against Japan to go off the boil, and Congress and the public seemed to lose interest in the Japanese threat. But only a few years later, things returned to business as usual, and Japan's trade surpluses reattained their former size. Japan's surplus against the U.S. in 1985 was $46.2 billion, but by 1993 it had reached $59.4 billion. (It was $74.1 billion in 2008 before dipping with recession.)

Relying on currency revaluation to rebalance our trade also assumes that the economies of foreign nations are not rigged to reject our exports regardless of their price in local currency. Many nations play this game to some extent: the most sophisticated player is probably still Japan, about which the distinguished former trade diplomat Clyde Prestowitz has written:

If the administration listed the structural barriers of Japan--such as keiretsu [conglomerates], tied distribution, relationship-based business dealings, and industrial policy--it had described in its earlier report, it would, in effect, be taking on the essence of Japanese economic organization.

We cannot expect foreign nations to redesign their entire economies just to pull in more imports from the U.S.

In any case, the killer argument against balancing our trade by just letting the dollar fall comes down to a single word: oil. If the dollar has to fall by half to do this, this means that the price of oil must double in dollar terms. Even if oil remains denominated in dollars (it is already de facto partly priced in euros) a declining dollar will drive its price up. The U.S., with its entrenched suburban land use patterns and two generations of underinvestment in mass transit, is exceptionally ill-equipped to adapt, compared to our competitors.

Fundamentally, allowing the dollar to crumble is a way of restoring our trade balance and international competitiveness by becoming poorer. That's not what Americans want, or should want. A tariff is a much better solution.