403 January 11, 1985 THIRTEEN MYTHS OF A STRONG DOLLAR INTRODUCTION
The U.S. dollar continues to soar on world money markets.
It has gained in relation to the once mighty trio of the West
German mark, Japanese yen, and Swiss franc. It has humbled the
British pound, French franc, Canadian dollar, and. Italian lira.
Once again, the greenback appears to be e veryone's favorite
currency a sign of U.S. economic health. U.S. exporters see the
dollar's strength as a threat, since the decrease in the value of
foreign currencies against the dollar means that more foreign funds
are required to purchase U.S. goods. T h is inhibits U.S. exports
and it is maintained, has created a U.S. trade deficit of over $100
billion for this year. Such U.S. industries as automobiles steel,
textiles, and shoes see the dollar's strength as prompting
increased sales of less expensive imp o rts at the expense of the
domestic producers For many, this popularity brings problems and is
not seen as Still others view the dollar's strength as an
indication of serious problems with the international monetary
order. The commentators argue that the d e mise of the fixed
exchange rates and their replacement by floating rates have caused
frequent destabilizing shifts in exchange rates, greatly hindering
inter national economic activity. They insist that a new
international monetary order be established to restore tranquility
to interna tional trade.
The trouble is, the notion that the strong dollar is a problem
rests on myths--a baker's dozen, at least. These myths must be
demystified and rejected so ,that attempts to llsolve'l the dollar
"problem" do not inflict serious damage on the U.S. economy 2 MYTH
1: THE DOLLAR IS OVERVALUED The value of floating currency such as
the dollar is deter mined by market forces of supply and demand.
Between late 1980 and 1984, strong demand for the dollar pus,hed up
its v a lue by 30 percent against the Swiss franc, 40 percent
against the British pound, 50 percent against the German mark, and
over 100 percent against the French franc.l The notion that the
dollar is 'lover valuedll suggests that some Ilnatural" value of
the d ollar is lower than the market value and that its current
strength is artificial.
The dollar's value, in fact, reflects the underlying conditions of
the U.S. economy and the degree of international confidence in U.S.
political stability and long-term econo mic health. In this sense,
the dollar exchange rate is always correct, responding as it does
to the demand for trade and the investment in dollars.
In the mid-1970s, rampant inflation, the debacle in Vietnam the
spectacle of an American president being chased from office the
sudden surge in oil prices, and other factors made the Ameri can
political and economic system appear fragile. The U.S. was on the
retreat on many fronts. And accordingly, the dollar seemed less
attractive and less secure for investors and lenders.
The Reagan years have done much to erase this pessimism. Today a
robust dollar reflects America's political stability, economic
streng th, productivity, and high return on direct investment that
have been spurred by policies rewarding private initiative and
entrepreneurship The U.S. today is viewed by investors as a safe
haven, and the dollar, as a secure store of value Economic and none
c onomic factors thus contribute to the dollar's current strength.
Far from being artificial or excessive the strong dollar is linked
directly to the strong U.S. economy and mirrors international
confidence in U.S. economic and political stability a rarity i n
today's world MYTH 2: THE U.S. BUDGET DEFICIT KEEPS THE DOLLAR HIGH
Arguments that the budget deficit pushes up interest rates and that
high interest rates account for the strength of the dollar ignore
two facts 1) There are no hard data or statistical evidence to
verify what is only an instinctive feeling that budget deficits are
linked to high interest rates. Explains economist Thomas M.
Humbert From mid-1981 to the present [January 19841, the Treasury
bill rate dropped to 9 percent from a 15 percent p eak Arthur Burns
The American Trade Deficit in Perspective Foreign Affairs Summer
1984, p. 1059. I 3 This large drop occurred at the same time that
deficits rose from 110 billion to nearly $200 billion. U.S real
interest rates (that is, adjusted for infla tion also dropped
between 1981 and 1983, although erratically In his report, Humbert
cites studies finding little direct and certain correlation between
budget deficits and interest rates.
Interest rates, note Humbert and others, are dependent on factors m
uch more telling than federal deficits, such as business expecta
tions, industrial productivity, and the size of the government
budget interest rates, high interest rates would be only a partial
cause of the strength of any currency investment and other c o
nsiderations are more important deter minants of exchange rates. In
fact, some countries with high interest rates have weak currencies.
The prime lending rate charged by commercial banks in France, for
instance, is currently about 12 percent, and in Italy , the figure
is 18 percent.3 Both are above the U.S. prime rate. Yet the franc
and the lira have dropped sharply in value over the last few years.
The general strength of an economy, its business climate,
entrepreneurial opportunities, and similar factors evidently are
more important than interest rates in determining international
exchange rates 2) Even if there were some causal link between
deficits and Prospects for return on direct MYTH 3: THE CURRENT
STRENGTH OF THE DOLLAR IS U"UXX,DENTED.
Compared to the late 1970s, today's dollar does seem high.
But there is no reason to use that period as a baseline in measur
ing.the dollar. Indeed, despite its recent surge, the dollar barely
has regained the ground lost during the 1970s. In 1970 for
instance, the d ollar bought 4 West German marks, 4.3 Swiss francs,
and 370 Japanese yen. During the 1970s, the U.S. weakened the
dollar considerably by excessive monetary expansion. Mean- while,
oil shocks, U.S. wage and price controls, and Watergate among other
factors , made the U.S. economic and business climate less
attractive. The dollar began plunging, and by 1980, many believed
that it would remain a Ilweak'l'currency. That year the dollar
bought only 1.7 German marks, 4.2 French francs, 1.65 Swiss francs,
and 225 Y en. Now the dollar buys over 3 marks over 9 French
francs, 2.50 Swiss francs, and 245 yen. However when the exchange
rate of the dollar is stated in terms of special drawing rights
(SDRs a weighted group of currencies used by the International
Monetary Fu nd as an economic benchmark, the dollar in 1984 merely
equals its 1970 ~trength.~ If the value of the Thomas M. Humbert
Understanding the Federal Deficit. Part 3: The Unproven Impact
Heritage Foundation Backgrounder No. 330, January 27 1984, p. 7.
The Economist, November 24-30, 1984, p. 118.
The Economist, October 20-26 1984, p. 108 4 dollar levels off, or
even drops slightly, it will fall below its 1970 level MYTH 4: THE
STRONG DOLLAR INDICATES A SERIOUS PROBLEM OR WEAKNESS IN THE U.S.
The oppos ite is true. The strength of the dollar is due in large
part to the robust U.S. economy. The recovery in the U.S was solid
and moved swiftly into expansion, while inflation has dipped
dramatically and remains low. Unemployment has declined the U.S.
econom y has created over seven million new jobs since 1980, and
interest rates are below their level of the late 1970s.
Even with interest rates higher than in the early 1970s, the
recovery has moved ahead strongly, and faster than in most other
industrialized c ountries. Consequently, foreigners continue to
demand dollars so that they can invest in the U.S. economy. They
find it very profitable to share in the strong U.S. recovery by
borrowing or buying dollars, even at high exchange rates MYTH 5:
THE STRONG DOL LAR HINDERS THE RECOVERY IN EUROPE.
This notion reverses cause and effect. It is the sluggish European
recovery that has made the U.S. economy attractive to investors and
thereby contributes to the dollar's strength.
Reagan Administration measures that im prove the climate for
business boost foreign confidence in the U.S. economy. Toyoo
Gyohten of the Japanese Finance Ministry notes that "the dollar is
a symbol of America's political and economic strength Fritz
Leutwiler of the Swiss National Bank adds tha t "The U.S. is seen
by investors as young, flexible, and dynamic and Europe old
sclerotic, and much less flexible. It's not just psychological I
think the reasoning behind [the dollar's rise] is quite correct.Il5
At the London economic summit of June 1984, European leaders
marveled at Americals economic vitality, its ability to create
jobs, and its "entrepreneurial spirit.If6 In contrast, reports the
London Economist, IIYoung, innovative European firms labor under
crippling burdens that their American and J apanese counter parts
do not have.If7 The respective strengths of the economies and
currencies of the U.S. and Europe reflect, in large part, the
wisdom or folly of their respective domestic economic policies.
The strength of the dollar, moreover, allows Europeans to export
large quantities of goods to the U.S. In this sense 5 "The
Superdollar," Business Week, October 8, 1984, p. 167.
Hobart Rowen Jobs Issue Enhances U.S. Clout at Summit, Official
Says French 'Cannot Get Over It The Washington Post, June 11, 1984,
p. Al Europe's Technology Gap The Economist, November 24-30, 1984,
p. 95. 7 5 America's record imports are serving as a locomotive for
Western Europe's economic recovery. On the other hand, capital
flight from Europe slows i ts recovery. But such flight and the
strong dollar are the results of unwise economic policies, not the
cause of European weakness. Indeed it would appear that West
Europeans prefer to blame the U.S. for their troubles. When the
dollar was falling in the late 1970s, Europeans complained bitterly
that this was damaging their economies seriously MYTH 6: THE STRONG
DOLLAR TRIGGERED THIRD WORLD DEBT.
The strong dollar harms less developed countries, it is said, since
debts to U.S. banks must be paid in "expens ivett dollars and
interest payments on loans often are tied to U.S interest rates.
Though this argument contains some truth, it overlooks the deeper
causes of the problem. Many debtor coun tries borrowed dollars
recklessly, gambling that inflation would c ontinue to weaken the
dollar and hence reduce the value of their debts. The sharp drop in
U.S. inflation means that they bet wrong and now must pay off loans
in noninflated money.
The root of the problem is the nature of the borrowing and
investment polici es of the developing countries--not American
success in controlling inflation. For example, South Korea's debt
of $4.0 billion ranks-just below the $44 billion figure for
Argentina. Yet South Korea has managed its borrowing and invest
ment carefully and c o nstructively and is paying both interest and
principal on schedule.8 On the other hand, Argentina and many other
countries used borrowed funds to finance excessive con sumption,
high wages for state bureaucrats, graft for corrupt politicians,
and.bailout m oney for failing state-owned or operated
enterprises.g underlying weakness of such flawed policies. A weaker
dollar might ease pressures on debtor countries, but it would not
solve the debt crisis. More fundamental changes must be made The
strength of the dollar has only aggravated the The strong dollar,
of course, also offers opportunities to debtor countries. With a
strong dollar, debtor countries can export goods much more readily
to the U.S. and thus earn valuable foreign exchange MYTH 7: THE
INFLUX OF FOREIGN CAPITAL ENDANGERS THE U.S. ECONOMY The strength
of the U.S. economy has attracted considerable foreign investment.
Reports Business Week 8 "World Debt In Crisis: Watch List Wall
Street Journal, June 23. 1984 D. 37 see Edward L. Hudgins Four
Steps to Resolve the Argentine Debt Crisis,"
Heritage Foundation Backgrounder No. 365, July 10, 1984. 6 Total
private foreign investment in the U.S. is expected to rise to 715
billion this year, up from $597 billion in 1983 and $533 billion in
1982 Foreign purch ase of U.S. Treasury securities totaled $6.5
billion in the second quarter, roughly twice the previous record
quarterly rate.1 Some economists warn that American interest rates
have encouraged capital flow into the U.S making the U.S. dependent
on "footlo ose" foreign capital, which suddenly could be withdrawn.
The general fear of foreign capital dependency is groundless
economically. Most countries have relied on foreign capital at
critical stages of economic expansion. Until this century, the U.S.
depende d on British capital to build railroads and other heavy
industry. The pound sterling also funded development in Germany,
Argentina, and many other countries. Later, German capital played a
similarly important development role. After World War 11, dollar i
nvestments throughout the world led to worldwide economic growth.
There is nothing disturbing, therefore, about overseas investors
having confidence in the U.S. economy. Direct capital investment,
from whatever source, is in the economic interest of the re
cipient. Indeed, such investment is modernizing many U.S
industries, making them much more efficient and internationally
MYTH 8 THE U.S. ECONOMY.
AN ABRUPT DROP 'IN THE DOLLAR'S STRENGTH COULD DISRUPT Some
economists argue that, even if fore ign investment is good for
America, an abrupt drop in interest rates or the dollar's strength
could prompt a sudden exodus of foreign capital could cause serious
economic disruption, they claim, undermining attempts to finance
the budget deficit with fore i gn funds and thus forcing Treasury
borrowers to compete more directly than they have been with private
sources of capital This Such a drop is very unlikely. The dollar's
strength and the corresponding desire to invest in America are due
in large part to t h e strength of the U.S. economy. Unless
Washington raises taxes or the Federal Reserve Board strangles the
economy by restrictive monetary policy, the U.S. economy almost
surely will remain sound. And since investment opportunities
elsewhere in the world w ill develop only gradually, as other
economies begin to revive, an abrupt capital flight from the U.S.
Other factors will stabilize the value of the dollar. The dollar is
the dominant international currency, for example, used lo Business
Week, op. cit 7 as a reserve and store of value in most central
banks purchases must usually be paid for in dollars, and in
countries with serious monetary problems, the dollar has become an
alterna tive currency. In Argentina, for instance, one banker
estimat e s that enough black market dollars may be circulating to
pay off the country's 44 billion national debt.ll of the dollar
means that it enjoys considerable immunity from sudden changes in
the strength of the U.S. economy Oil This reserve status MYTH 9
U.S. , HARMING THE ECONOMY products more easily and at lower
relative cost than if the dollar were weak. But far from harming
the U.S. economy, this helps it. For one thing, it helps keep
inflation down. For another, when Americans spend less money on
foreign g o ods, they have money left over for other purchases.
also means that consumers receive.more goods while paying out less
of their income. Competition from imports, meanwhile, helps keep
down the prices of domestically produced goods. U.S. indus tries
must s e ek more efficient production methods and must cut costs to
compete with imports. In the case of export firms, such action has
made production leaner and more innovative, laying the foundations
for a more efficient export sector THE STRONG DOLLAR LURES CHE AP
FOREIGN GOODS INTO THE The strong dollar indeed allows Americans to
purchase foreign The dollar's strength MYTH 10: THE STRONG U.S.
DOLLAR HARMS U.S. INDUSTRY.
Any economic condition affects' various sectors of the economy
differently. The dollar's stre ngth, for example, makes it more
difficult for certain U.S. industries, such as textiles and steel,
to compete with foreign goods. Many export-oriented industries
similarly suffer On the other hand, those industries purchasing
imported raw materials or ca p ital goods do so at a bargain,
thanks to the dollar's strength. This can lower their production
costs and sale price. Example: industries using steel as a primary
component of their product (such as autos, major appliances, and
farm machinery) benefit fro m purchasing less expensive steel.
Just as U.S. consumers benefit from the increased purchasing power
of the dollar so too do many U.S. industries--thereby creating jobs
and wealth All import-dependent industries benefit MYTH 11: THE
STRONG DOLLAR LEADS TO THE "DEINDUSTRIALIZATION" OF AMERICA,
BECAUSE OF CHEAP FOREIGN GOODS.
It sometimes is argued that all but a handful of U.S. indus- tries
eventually will be destroyed by cheap imports. The U.S l1 Jackson
Diehl Shopping Sprees, Speculation Help Argentines Survive
Inflation The Washington Post, September 4, 1984, p. A13 8 will be
left with a 'Iservice1l economy, it is said, with most people
working as poorly paid sales clerks. trial base will be destroyed.
In short, the indus The fact is, however, that the s trong
purchasing power of the dollar frees capital for investment,
research and development the modernization of existing industries,
and the creation of new industries. Business Week reports that the
strong dollar is leading to changes that will graduall y improve
the U.S. competitive position, even against the Japanese.
Last year alone 11.3 billion of foreign investment went directly
into plant and equipment and 6.4 billion into the stock market.
These. billions are making an enormous contribution to rebu ilding
the industrial structure that will make the U.S. more
competitive.12 The positive industrial e.ffects of the strong
dollar already are beginning to be felt. A St. Louis Federal
Reserve Bank study, for instance, reports that U.S. export growth
has b een more rapid in this economic expansion than in the
1975-1976 and 1980-1981 upturns.13 MYTH 12: THE STRONG DOLLAR
CREATES U.S. UNEMPLOYMENT.
The evidence is to the contrary. As the strength of the dollar in
foreign exchange has increased, unemployment in the U.S. has
decreased. The U.S. economy has created over seven million new jobs
80. Yet in Western Europe, with its lower valued currencies, from
two to three million jobs have been lost in the past decade, and
unemployment is viewed as a long-term problem.
The stronger dollar of course, has reduced employment in some
export-oriented industries, though industries using imports have f
ared well. The root of the problem in many heavy industries
however, is that workers are making wages much higher than the
market can handle. In these cases the strong dollar 1s only one
cause of the problem, at most, accelerating fundamental realignment
in the world economy.
MYTH 13: A WEAKER DOLLAR WILL HELP U.S. EXPORTERS A weaker dollar
would not necessarily help U.S. exporters in the short run Trade
adjustment tends to lag behind changes in exchange rates. According
to a Congressional Research Service study Business Week, op. cit l3
Ibid. l4 Lawrence Ingrassia Persistent Joblessness Still Troubles
Europe in Wake of Recession Wall Street Journal, November 13, 1984,
p. 1. 9 If the quantitative response to lower foreign prices is
slight in the short run, the proportionate increase in the quantity
of exports [by U.S. companies] will be smaller than the
proportionate .fall in price [of U.S export goods and less foreign
exchange will be earned from export sales after the depreciation
than before.15 In other words, since export sales and revenue tend
to lag behind currency depreciation and export earnings at current
trade levels the chances are that export earnings would drop with
currency depreciation curve'l effect could last as long as two
The CRS st udy suggests that this so-called I'J It is far from
certain, moreover, that a weaker dollar would aid American
exporters in the long run. Explains economist A Wilmots-Vandendaele
From 1976 to 1978, despite the plummeting dollar, the U.S. trade
gap widened : It jumped from $17 billion to 40 billion and from
then until, 1982 remained in the range of 36 billion to $42 billion
while the greenback lost 31 percent in value to the yen, 21 percent
to the mark, and 6 percent to the pound and the franc.16 A weaker
do l lar might help particular export firms in the long run, but it
is questionable whether the U.S. export sector as.a whole would
gain. The nature of foreign demand would deter- mine the change in
export income for each company, while some effects of the wea ker
dollar would affect exporters adversely.
Example: When a weaker dollar makes imports more costly, pressure
eases on union negotiators, leading them to push for higher wage
contracts. This increases production costs.
A weaker dollar's impact on trade, therefore, must be examined
industry by industry.
CONCLUSION In the past few years, the U.S. dollar has regained much
of the strength that it lost during the 1970s. This is no cause for
alarm. The dollar is not a "problemtt requiring a government
solution The dollar's strength reflects the strength of the U.S.
economy; It reflects many economic and noneconomic factors.
Not surprisingly, therefore, the strong dollar is generally good
for the U.S. economy. Those who wish to weaken the dollar in order
to inc rease U.S. exports misunderstand the causes and consequences
of the strong dollar. They fail also to realize Thomas F. Dernburg,
Flexible Exchange Rates: Exceptions and Reality. An Analysis,
Congressional Budget Office Report No. 84-985, June 22, 1984 A. W
ilmots-Vandendaele A Weaker Dollar Might Not Curb 'the Trade
Deficit Wall Street Journal, September 6, 1984, p. 28 p. 34. l6 10
that the negative consequences of a weakened dollar would far
outweigh any initial modest trade benefits for concern, a strong
dollar is a cause for satisfaction and pride Rather than a cause
Edward L. Hudgins; Ph.D.
Policy Analyst Policy Analyst Virginia Polk assisted in the
preparation of this study.