Back Talk: The Weak Dollar and America's Pres...

The Weak Dollar and America's Prestige

Over the past few years, I could have written about a billion blog posts saying that I basically agree with whatever Lawrence Kudlow is saying about the American economy. It therefore caught me by surprise when he weighed in with this opinion:

Resurrect King Dollar

By Lawrence Kudlow
Tuesday, March 4, 2008

If Sen. John McCain wants to run as a candidate of change, and if he’s interested in distancing himself from President Bush on some issues, he should reverse the declining fortunes of the Bush wartime dollar. America’s prestige is on the line.
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Right now the greenback is in virtual freefall. It’s a disorderly drop that’s picking up speed. In the last month the dollar has fallen 5 percent. Over the past two years it has declined 30 percent against the euro. In the past six months it has dropped nearly 20 percent versus the yen. Measured in terms of a basket of industrial currencies, the dollar is now below its 1970’s level.

Consequently, for the first time in a decade I’ve become genuinely worried about inflation. Over the last year and a half, consumer prices have climbed from 1.5 percent to nearly 4.5 percent. Prices are rising today faster than average hourly earnings for the non-management workforce. As real incomes go down, so goes the consumer.

I certainly agree that inflation is a big concern. And it's true that, in theory, a weak dollar can stir inflation by making imported goods more expensive. But the dollar has been weakening dramatically for a long time. What effect has that had on inflation so far? To find out, I dug up numbers on (a) the exchange rate with the euro ">here and (b) the U.S. inflation rate ">here. I computed average annual rates for both and plotted them up for the years 2001 through 2007. Here is what I found:


The value of the dollar in relation to the euro is shown by the magenta line and can be read of the left vertical axis. In 2001, one dollar would buy you a little more than one euro. In 2007, a dollar would get you only about .75 euros. Thus, during the Bush years, the value of the dollar has fallen by a whopping 35%.

The inflation rate (CPI-U) over those same years is shown by the blue line and can be read off the right vertical axis. Except for 2002, when it was quite low, inflation has ranged between 2.3% and 3.4%. There does seem to be a slight upward trend in recent years, but it is not very large in light of the dramatic decline in the value of the dollar. That's not to say we shouldn't worry about this issue, but it does seem that the relationship between the value of the dollar and the rate of inflation is not overwhelmingly strong. Also, the weakening dollar is helping to finally lower the trade deficit:


This chart shows the current account deficit expressed as a percentage of GDP according to the International Monetary Fund (IMF). It is conspicuously huge (no other major industrialized nation has a deficit anywhere near this large), but it is coming down a bit now, largely because of the weaker dollar. And the increased exports that come with a weaker dollar are fueling what little GDP growth we have right now. With all that in mind, I'm not quite as enthusiastic as Kudlow is about deliberately strengthening the U.S. dollar.

But I guess the real source of our disagreement on this issue has to do with the idea that "America’s prestige is on the line." He elaborates on that point later in his article:

And if all this weren’t bad enough, the falling greenback is becoming a symbol of American decline. Folks are making fun of the dollar. Our enemies around the world are pointing to the unreliable dollar as evidence of American weakness. Weakness as a financial power. Weakness as a national-security power. Does an unreliable currency symbolize an unreliable nation?

I don't see it this way. It's true that many people mistakenly equate a lower dollar with a weak economy, but that just means that many people are misguided. For example, look at the value of the dollar from 2003 through 2007 in my chart above. It plummeted against the euro. Does that mean that the European economies were outperforming the U.S. economy over that long stretch of time? Hardly. On the most basic measure of economic health -- growth in GDP -- the U.S. has far outperformed the major economies of Europe (Germany, France, Italy and Britain):


The IMF estimates the value at 1.9% for the U.S. in 2007, but the actual value came in at 2.2% (so I assume the IMF will update their figure in due course). My point is that despite the dramatically declining value of the dollar, economic growth in the U.S. from 2003 to 2007 was phenomenal. I know you don't realize this because you get your news about the economy from mainstream media reporters, but it's not debatable, and the fact that we are now in a weak period of growth (and a recession may be in store for us) does not change that fact.

Worrying about the fact that people around the word will mistakenly interpret a weak dollar as a sign of America's economic decline is not something I'm going to waste any time doing. For similar reasons, I don't worry (at all) about America's declining "moral authority" or about the fact that popularity polls in France and Germany show that people there think the U.S. is not what it used to be and that it is one of the biggest threats to world peace. What they think about us is their business, not ours (and what we think about them is our business, not theirs). I know how shocking this way of thinking is to some people who have never taken one moment out of their lives to ponder the possibility that we gain nothing -- not one thing -- from an enhanced "standing in the world" (i.e., from an increased level of support in popularity polls). In actual practice, our "prestige," our "popularity," and our "moral authority" are all basically irrelevant. If those were enhanced to everyone's satisfaction (i.e., if we regained our moral authority or if we enhanced our prestige), yet Britain, France and Germany nevertheless consistently elected anti-American leaders who think that the U.S. is a depraved nation that has lost its way, that would be a concern for me because it would show that, in practice, these things matter a lot. Thus, my claim that we should not worry about our "standing" in the world is not born of arrogance. Instead, I've paid attention to how Europeans behave when they take a real poll (not a popularity poll). When they do that, they send the anti-American politicians (who seem to mirror the views of the electorate, at least according to popularity polls) into retirement. That this happened in both Germany and France -- two nations with relentlessly anti-American populations -- is nothing short of amazing, and it suggests to me that our low standing in various European nations does not translate into anything tangible. I haven't been able to detect a tangible cost, anyway.

All of this is in stark contrast to other opinion polls that do matter a great deal, such as the opinions that Muslims have about al Qaeda. We do not depend on the French having a high opinion of us, but al Qaeda does depend on the Muslim world having a high opinion of them. As their prestige and their "moral authority" drops, their recruitment efforts suffer and their financing declines. They don't have an economy of their own to keep them going. Al Qaeda is not a nation unto itself, so it depends on the support of people within the nations that it infests. As stated in prior National Intelligence Estimates, if their standing drops in the Muslim world, their recruitment efforts will suffer. That is a very tangible cost, and that's why I pay close attention to al Qaeda's "moral authority" and prestige in the Muslim world while pretty much ignoring America's moral authority and prestige throughout the world. When the day comes that America's supposedly suffering moral authority translates into something tangible, then I'll start to become concerned about it.Posted by Engram at 3/06/2008 07:38:00 AM