The recent collapse of the dollar vs. the Euro has intensified the debate over whether we should have a “strong” dollar vs. a “weak” dollar. The extent of the collapse is indicated by the fact that in January, 2002, you could buy a Euro for $0.86. Today, you will pay nearly $1.43, a whopping 66% increase. Should the United States have a strong dollar or a weak one? In an economy that didn't depend on the imports, the question would not be important. But, as we are dependent on foreign oil and foreign goods, the question is of critical importance to each and every American. They may find (as I do) the question of exchange rates to be supremely confusing, not to mention boring. Nevertheless, the price of the dollar affects each and every American consumer and worker, and does so every day.
Jane Jacobs, in Cities and the Wealth of Nations: Principles of Economic Life, explains the way currency fluctuations are supposed to work:
When a nation's currency declines in value relative to the currencies of the other nations with which it trades, theoretically the very decline itself ought to help correct the nation's economy. Automatically its exports become cheaper to customer nations, hence its export sales should increase; and at the same time, its imports automatically become more expensive, and this should help its manufacturers. Theoretically, then, a declining national currency ought to work automatically like both an export subsidy and a tariff, coming into play precisely when a nation begins to run a deficit in its international balance of payments... Furthermore, this automatic export subsidy and tariff ought to remain in play precisely as long as it is needed, no longer.
In other words, currency fluctuations function as an automatic way of balancing trade, no government intervention required. No spurious debates on free trade and protectionism, no political wrangling of any sort. However, in practice this doesn't actually happen. The major reason this happens is that we don't just import and export goods, we also import and export money, and these capital flows work in the opposite direction of trade flows, thereby confusing the signal.
International imports and exports of capital work in just the opposite way. If a country has been importing more capital than it has exported (by borrowing abroad, for example), the value of its currency is automatically bolstered. Conversely, if it has exported more capital than it has been importing (by lending, making gifts, paying interest on prior foreign loans, exporting the profits of foreign-owned industries), the value of its currency is automatically depressed to that extent.
This gives governments a way to manipulate the currency of another country, if they have a mind to. They can simply lend the gullible country vast amounts of money, keeping the value high, or buy up its currency to hold in reserve. Why would any country want to do such a thing, since it would not only be very expensive, but constitute a trade war and perhaps provoke a reaction? Well, in the short term, to smooth out trading fluctuations, such manipulation does no harm. However, a country convinced that it can only grow by exports and not by raising the living standards of its own people (thereby expanding its internal market) may well elect to manipulate its trading partner's currency. Is there such a country so ignorant of basic economics that it would spend its valuable capital to shore up the currency of another country rather than invest it in its own? Yes, there is.
That country is Communist China.
Granted, they are new to this whole “market” thing, and so perhaps haven't gotten it down yet. And since they have a long history of abusing their own people, a little more “market” abuse would hardly seem to make any difference. Finally, their “success” in international markets creates a strong constituency for continuing a rather foolish policy. But this success isn't real, and it is coming at a terrible price for their own people, a price that will one day have to be paid.
The Chinese also have another way of “cheating” in the game of international trade. They can simply “peg” their currency, the Yuan, at an artificially low rate. That is, they can guarantee that no matter how strong their currency gets, they will still give the same amount of dollars from for each Yuan; they alow the Yuan to trade only in a very narrow range (about 13 or 14 cents). In effect, this is an export subsidy and an import tariff by another name.
And this brings us to the subject of Wal-Mart, the “low-price” people. Wal-Mart just happens to be Communist China's largest trading partner, but its “low prices” are not the result of either a free market or of free trade. Rather, it is the beneficiary of government manipulation of the markets. In fact, Wal-Mart is an island of corporate privilege floating on a sea of public subsidies. These subsidies and privileges come from every level of government. At the local level, they often get special zoning and tax treatment from governments desperate for development, even if such “development” means impoverishing local entrepreneurs. At the state and federal level, the whole business plan is in fact a creation of the highly subsidized “freeway” system, (see “Free Markets, Free-ways, and Falling Bridges”), without which Wal-Mart would not exist. And our own government, for political reasons, tends to keep the value of the dollar artificially high (although that policy is weakening). But the biggest subsidy comes not from our government, but from the Chinese Communists. It is a subsidy that, in the long-term, must impoverish both countries. Our manufacturing is hollowed out, while the real needs of the Chinese people are ignored.
America has nothing to fear from real free trade and truly free markets. We benefit from having strong trading partners; the rise of Japan, Europe after the devastation of war, Taiwan, Korea, Singapore, etc., makes both us and them stronger. And on a level playing field, American workers and American firms can compete. Some firms it is true, have lost out, such as the auto industry. However, in that case it took a near conspiracy of stupidity on the part of both the companies and the unions, who worked hard in favor of their short-term interests and against their own long-term good. In more normal, and less arrogant companies and unions, even a small perception of the realities is sufficient to get them to adjust their products, technology, and compensation plans to counter the foreign competition. And this benefits everybody.
American consumers believe that they get a benefit from Wal-Mart's low prices, while American workers believe that they pay a high price in jobs, dignity, security, and even national survival. So who is right? The answer is that they both are. But the costs and benefits are not symmetric. American do get lower prices, in the short-term. But only at the cost of enormous and unsupportable trade imbalances, imbalances that most, sooner or later, come out in higher prices, higher taxes, higher interest rates, and higher unemployment or “reduced”employment (e.g., replacing well-paying factory jobs with poorly-paid “service” economy jobs, like maids or hamburger flippers). The benefits are short term, the costs are devestating to the economy and to the dignity and well-being of the workers, their families, and the country.
What's to be done? The American government must inform the Chinese that they must end their artificial currency policies and let the market price prevail. At the same time, America must get its own fiscal and monetary house in order, and not depend on huge loans from foreign governments to finance its day to day operations. Naturally, this must be done prudently, over an appropriate period of time. If the Chinese Communists persist in this trade war (to call it what it is), then we should “adjust” their currency for them, by gradually raising tariffs over a three to five year period to bring the costs of Chinese products to what they should be if their currency were correctly priced. On a level playing field, Americans can compete even with subsistence wages and low-cost lead painted products. This policy would benefit the Chinese people as well, as their government would have more funds to invest in the needs of their own people, and less supporting a corrupted American regime. Of course, such a policy will not be painless. Prices at Wal-Mart will rise and the happy-face price-cutter will not be quite as happy. But the pain will be short-term, the gain will be long-lasting. Just as the fall in the dollar has increased our exports to Europe, so the rise of the Yuan both cut imports and increase exports. That's the way it's supposed to work.
To answer our original question, the dollar should be neither “strong” nor “weak”; it should be right, its priced based on actual market conditions. But neither American nor Chinese trade policy can be based, in the long-term, on simply subsidizing Wal-Mart.