Should your Dollar Hit the Gym, or Keep Munching on Taco Bell?

Just last week President Trump allegedly rang the former national security adviser Michael Flynn at 3 a.m. asking him if a strong dollar or weak dollar was better for the US economy. Flynn responded to President Trump allegedly stating that he should ask an economist instead. While it may be concerning that the president is asking for advice on macroeconomic policy—if you can call it that—to a security advisor, this does open up a conversation on what is actually better for the US economy: a strong or weak dollar? It should be noted that President Trump is one of the first presidents to refrain from commenting on the dollar’s value. And as of December 2016 the dollar is at a 14-year high. For most of this century we have seen a strong dollar. So what does this mean for the average consumer and the US economy as a whole? And why is the US dollar’s value so high compared to other foreign currencies? An even better question may be, why has the dollar’s value remained so high over the past 14 years?

Whether you carry it around in its paper or plastic form, the US dollar is an integral part of any American’s life. Furthermore, the US dollar is perhaps one of the most important aspects of the global economy. US dollars are the most coveted and sought after currency in the world and are bought and sold by as any other good. So it’s not just you who loves to have a little more green in your wallet. Goods and services both domestically and internationally are bought and sold in US dollars. It seems clear why an individual may hit the forex markets on a given workday to buy and sell currencies to profit from their fluctuations. But countries like Japan and China don’t go to the NYSE or other exchanges to make money day trading. So then why do countries want the US’ currency when they have their own?

Countries like Japan and China have export driven economies, meaning that they have a positive trade balance Consider the role of net exports as a component in determining GDP, a large portion of the Chinese and Japanese GDP is from the positive NX (net export) value. As you may know from most of your “Assembled in China,” inscription on most of your possessions, China has a very large manufacturing sector. Exporting to the US and other developed states has allowed the Chinese economy to explode and grow over the past 30 years. US households use their income to purchase Chinese-made goods. Here, a large portion of China’s and Japan’s GDP is determined by these net exports to US consumers.

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Consumption expenditures by households has increased dramatically over the past 25-30 years, as net exports has become negative.

The process at first seems complex, but once broken down becomes a little simpler. Chinese goods are sold at a lower price than their US counterparts because of the low labor costs in China. Chinese firms get paid in US dollars, however, they cannot pay their workforce in US dollars. Instead, Chinese firms buy Yuan with US dollars. This, as a result, increases the supply of US dollars in the foreign exchange markets. The law of supply and demand tells us that when the supply of US dollars increases, the equilibrium price will decrease. This leads to a weaker US dollar. In turn a weaker US dollar means that the US dollar buys less Chinese goods. If your economy is export driven, the last thing you want to have is your main consumer buy less of your product.

Are US households really willing to accept price increases in most manufactured goods if it means that there’s more jobs in the US? While the National Security Advisor can’t answer that, I hope President Trump’s economic advisors can.

But wait, didn’t you say that the US dollar has been continuously stronger over the past 14 years? Shouldn’t the value of the dollar be weaker? If this is where the process stopped, then yes, the US dollar would be weaker when compared to other currencies. Well it doesn’t. The central banking system of China (essentially their Federal Reserve) buys up all the excess US dollars in the marketplace, thereby driving up the price of the dollar by reducing its supply. The central banking system of China then takes those dollars and purchases US securities—better known as US debt. The supply of debt is consistent and to some extent has allowed the Chinese to continue to keep the US dollar strong and exports high.

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Excluding years of recessions, (indicated by the vertical grey bars) the trade deficit has grown steadily since the 1990s, due in part to a stronger dollar.

So the benefits are obvious for China, but what exactly are the benefits for the US? Well, US households are able to purchase cheap consumer goods from China. The US dollar goes further in the international market place, and there are more goods for consumption in the US. However, a stronger dollar also means that we run a massive trade deficit, due in part to us consuming more and exporting less. This in turn means that the US’ NX value is negative, thereby lowering the GDP calculation. Here, American goods simply cannot compete with the same goods produced in China. This in turn means that there are fewer jobs in manufacturing. If President Trump wishes to bring jobs back to the US, the value of the US dollar must decrease. This will prove to be increasingly tricky as automation in both the goods and services markets take off. Unfortunately, this will undoubtedly come with repercussions. Are US households really willing to accept price increases in most manufactured goods if it means that there’s more jobs in the US? While the National Security Advisor can’t answer that, I hope President Trump’s economic advisors can.

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