The Unsinkable Dollar

A widening trade gap is supposed to sink a currency. But our trade deficit keeps growing and the dollar is rallying. What’s going on? The Wall Street Journal opines:

At the end of the day, a currency isn’t a true commodity, like gold or wheat. It is a store of value. Its supply is determined by a central bank, which has a monopoly on its creation. Foreign-exchange markets are dominated by a cartel of central banks, and currency rates are a function of those central banks’ monetary policies.
Nowhere is this truer than in Asia, where central banks happily attempt to manipulate foreign-exchange rates. China, Malaysia, and Indonesia have all intervened heavily in the foreign-exchange market this year. (A notable exception has been South Korea. The won has responded by holding steady against the greenback this year, helping to contain inflation.)
The relative economic health of nations of course also influences currency demand. The U.S. economy has continued to power along while most of Asia is gradually slowing and Europe bumps along. Most economists expect America to expand at around a 3.5% rate in the fourth quarter and into next year — nothing to sniff at. Employment is rising. So far consumer spending remains strong, despite the slowdown in housing. This isn’t a picture of a country in distress.
Contrary to popular wisdom, all this has happened while the U.S. current account, a measure of commercial trade in the balance of payments, hit a record $66.10 billion in September. The U.S.-Sino trade deficit to October alone was $80.4 billion. Some economists are now predicting deflationary pressure on the yuan. That’s right: Wall Street was predicting the Chinese currency would rise only a few months ago, and now an opposite trend may be emerging. That shows how fickle foreign-exchange markets can be.
It also shows how politicians venture into this area at their peril when they get excited about the effects of shifting exchange rates on national “competitiveness.” The overall economic causes and effects that derive from a currency’s relative value are by no means as easily discerned as protectionists like to pretend, as witness the number of countries that have benefited from muscular currencies. That seems to be happening right now as the U.S. prospers with a dollar that has surprised the markets with its relative strength.

Posted by on November 28th, 2005 at 5:45 am


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