Lately, news coverage has been talking about how the dollar is tanking all over the world.  It’s tanking so hard that some are wondering if it will remain the currency of the world for much longer.  That’s a bunch of crap, and that’s not simply because I’m an arrogant American, but that isn’t the point of this post.

Today I want to talk about this weak dollar stuff and we’ll see if it’s really as bad as we’ve been convinced it is.  But first, let’s have a quick Weakon class on currencies.

Ever since the gold standard died like the Nixon administration, the value of the dollar in the rest of the world has fluctuated like a stock price.  You can actually see how well it’s doing relative to other currencies.  You can even trade currencies like a stock to make money, or you can simply check on them at websites like Forex.com.  I’ve never traded currencies, but then again I don’t trade.

The easiest way to see how the dollar, or greenback, is performing in the world markets is the US Dollar Index, which is the dollar vs a basket of currencies.  You can see a chart of it here.

When the dollar is strong, our dollars are able to buy more foreign goods.  For example, imagine the US and Canadian dollars were equal in value 1 for 1.  Now if the US dollar gained 10 cents on the Canadian dollar we could exchange 1 dollar for $1.10 Canadian.  This is an immediate 10% discount on anything we might buy in Canada.  Americans with a strong dollar are going to be interested in buy foreign goods because we can get them cheaper.  This keeps inflation in check and makes the dollar more important to the global economy.

But there is a caveat.  The more money we spend overseas, the less money we spend here in the states.  We’re basically shipping out our precious greenbacks.  This, and a number of other factors to be discussed in a second, can contribute to the eventual weakening of our precious dollar.  A weak dollar makes importing goods (like oil) more expensive (which explains the recent run-up in oil prices).  This creates inflation.  But there are good things too.  Other countries will find it enticing to buy American goods because they can now get them on the cheap.  Not only that, they might look into investing in the US, for example a foreign car company setting up a factory in the US.  This brings tons of foreign money back into the US, which stimulates the economy.

Before we answer the question of which type of dollar we want, let’s look at what factors contribute to the strength of a currency.  Naturally, the economy is a big factor, and in a nutshell that answers the question.  But we can get more specific.  The money supply is huge.  Right now there are a lot of dollars out there, the more dollars there are the less they’re able to buy, so the dollar is devalued on the world market.  Political upheaval can be a factor, though less so for the United States.  The flip-side is big though, when a country is unstable the citizens may run to the dollar for stability, which strengthens the dollar.  The argument exists that interest rates play a factor as well.  For example, if I can get 5% on my cash in London VS 2% on my cash in the US, I’ll take it to the UK.  It is my belief that this isn’t significant enough, but then again I’m not a currency expert.  This is enough to cover the bases though.

So finally, what kind of dollar do we want?  Well we want to have our cake and eat it too.  We want a strong dollar, but we want a weak one too.  It just depends on our mood.  When our economy is in the pooper, the Federal Reserve will actually devalue our currency in order to induce foreign investment in the country.  That is to say, they will purposefully devalue our currency, probably by introducing more cash into the market, which brings foreign money here.  Though the media may be surprised by the news of the dollar tanking, people like Bernanke are sitting in their offices sipping tea and thinking, “it worked”.  When times are good we want a strong dollar to combat inflation.  It’s a difficult balancing act that is similar to the argument of whether we should have lower or higher interest rates.  But as always, that’s another day.

By The Weakonomist

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categories: economics, government