- The United States imports considerable amounts of goods, particularly from East Asian export-oriented economies such as China, Japan and various other Southeast-Asian countries.
- Since China and Japan don't have much demand for U.S.-produced goods, United States runs large trade deficits with both countries.
- Under normal circumstances, trade deficits would correct themselves through depreciation of the dollar and appreciation of the yen and the renminbi. However, Chinese and Japanese governments are interested in keeping their currencies low with respect to the dollar to keep their products competitive. To achieve that, they are forced to buy large quantities of U.S. treasury securities with freshly-printed money.
- Similar mechanisms work in the Eurozone with the euro and its satellite currency (Swiss franc). The Eurozone is somewhat less coupled to the U.S. economy, so the euro has been allowed to appreciate considerably with respect to the dollar.
In my opinion, we need a stronger dollar policy. Presently the weak dollar makes US exports attractive and overall shrinks the trade deficit, which is great for us. But, where does it end?
Continued weak dollar policy could unravel Bretton Woods II, because it devalues dollars so much that foreigners face massive losses, simply by holding dollar reserves. That in turn greatly diminshes our ability to shape events in the world.
Strong dollar policy naturally does the reverse. It enhances Bretton Woods II, and helps keep global peace by ensuring that we are all happy trading partners. It ensures our own continued economic health, by encouraging holders of dollar reserves to continue holding them, rather than dumping dollars for another currency.
Yet the downsides to stronger dollar policy ripples through US exports and the trade deficit, eventually to US jobs. Inflation will continue, which readily explains reluctance of the current US administration to change things. Yet events will eventually force their hand.
As an aside, this protectionist streak running through the country could help unravel Bretton Woods II as well. I'm talking to both Democrats and Republicans here. Free trade not only benefits all trading partners, and lifts millions out of poverty, it also helps keep the peace.
Start engaging in protectionist behavior, and other countries will be forced to retaliate in kind. As global resources like air, oil and water become ever more scarce or overused, we need global cooperation more than ever before. Like it or not, we are dependent on other nations. Calling for "Manhattan Projects" to fix problems doesn't change the immediate situation.
Update, from today's Financial Times: Sovereign funds cut exposure to weak dollar. As one ADIA staffer says in the article, echoing the pain felt by all countries pegged to the weakening U.S. dollar, "We are suffering. We are importing inflation for no reason."