Currencies
Posted by Shawn on January 30th, 2011 – 5 Comments – Posted in Finance*Post by Shawn*
This is going to be the first of two pet peeves of mine and both concern the conclusions people jump to based on what they hear or read without really knowing much about a situation. This one is about currency valuations and how people suddenly conclude that it’s a bad thing that the dollar is weak. I understand that ‘weak’ has negative connotations and ‘strong’ has positive ones, and for that, I blame whatever economist first used those words to explain currencies. The important thing to note is that those terms represent only how much of one currency you can buy with another (e.g. how many pounds sterling I can buy with 1 USD) and is always relative (i.e. there is no objective good or bad valuation). The common misconception is that when the dollar is weak, that is bad. What most people don’t understand is that within the US (not traveling and only from a US perspective), the value of the dollar relative to other countries is essentially irrelevent – i.e. your money in your bank account isn’t losing value. In fact, a weak dollar can actually be a good thing. This makes US products cheaper abroad and thus will increase exports, creating more American jobs and raising our GDP. This does make imports more expensive, but this will again drive domestic production and jobs. This is why the US has a problem with the Chinese since they keep their currency artificially low in order to strangle imports and promote exports. And it’s important to note that currency valuation is what I like to call a secondary indicator of the economy and has no meaning in and of itself. So, if one wants to change the value of the dollar, direct currency intervention isn’t the way to do it; instead change the underlying fundamentals – i.e. if you boost the economy and make it more attractive it will naturally raise the view of the dollar. This is only a surface-scratching view of a very complex subject, which, I guess is really my point. One should be very careful jumping to conclusions without having a good understanding of a complex situation.
If the value of the dollar drops suddenly, don’t we owe less money to what we borrowed?
@ Crazy Pants…
If you owe that money in dollars than there is no change. A weak or strong dollar is in reference to other currencies.
@Ms. Crazy Pants
You might be thinking of inflation. If there are large levels of inflation after taking out a loan, then the amount you owe at the time of repayment would have less buying power than that same amount did when you first took the loan. You still owe the same amount, but the relative value – its purchasing power – has changed.
Sorry, I was thinking in relation to our debt with China. I thought if the dollar got weak that we wouldn’t have to pay China back as much money.
Sorry for taking awhile to reply, and again I’m not an expert, but changes in the value of the currency shouldn’t affect debt held by other countries. Since the debt is held in dollars and paid back in dollars, there would be no conversion and so no change based on any change in currency value.
It is interesting to note though that the trade imbalance with China doesn’t affect the value of the dollar relative to the yuan because of their policies. We buy more products from the Chinese than they buy from us, so the dollar should go down. The Chinese though convert these monies back into dollars to buy treasuries, hence increasing the demand for and value of the dollar. This keeps their exports cheap and economy booming at the expense of our goods. This is also one reason why I’m not worried about China holding a lot of reserves. One, they’re essentially investing in us because we take that money and put it back into the economy, and two, and devaluation of the dollar would hurt their economy.