protectionism and a depreciating dollar

From David Ranson in the WSJ, some additional clarity on the impact of the dollar on foreign trade AND foreign investment-- and thus, the health of the economy and the market's assessment of that health. (Applications of these principles might also be helpful in interpreting China's currency interventions.)

Reactions to the dollar's relentless decline have been mixed. Some think of the dollar as an instrument of government policy and believe that a cheapened dollar protects the U.S. from foreign competition. Others assert that movements in the dollar are a natural result of market forces. My work places me among a third group of observers who see the dollar's decline as unnatural and dangerous.

The value of the dollar measures market confidence that the government will preserve the purchasing power of its debt -- hardly a question that should be left unanswered or delegated to markets to guess.

A fall in the dollar is the first in a familiar sequence of closely connected and undesirable events. The steps in this process (not necessarily always occurring in exactly the same order) include substantial rises in the prices of gold and other commodities, increasing inflation, a bear market in bonds, capital outflow from the U.S. economy, financial uncertainty, a decline in the investment performance of equities, Fed rate hikes and flattening economic growth.

In today's world, currency movements are directed in large part by protectionist sentiment. Granted, protectionism is no longer so much a matter of tariffs or quotas for specific industries. Usually it's a unified effort to cheapen the dollar relative to foreign currencies so that (it's hoped) U.S. exporters will gain a price advantage -- or overcome a price disadvantage.

Belief in this theory lives on despite its preposterous implications. If we could make the dollar completely worthless, the logic goes, domestic producers would wipe their foreign competitors off the map, and the U.S. economy would take over the world! The fallacy is that international prices are set by competition and habitually compensate for currency changes. As many countries have found out, the end result of allowing the value of a currency to depreciate is hyperinflation and economic collapse -- as in Weimar Germany in the 1920s and in Zimbabwe today.

Nevertheless, too many people believe that what's good for exporters must be good for the whole economy. The fact that exports underperform when the economy grows best, and outperform when the economy grows least, does not sway them....

Connected to this, people only focus on exports of goods and services-- rather than also including "exports" of investment, as those in foreign countries often decide (reasonably) to invest in the American economy with their dollars instead of buying our stuff.

The touchstone for protectionism in the U.S. is the trade deficit. Historically when the deficit has widened, the foreign-currency value of the dollar has declined; when the deficit has narrowed the dollar has risen. Congressional intolerance for the deficit has been growing throughout this decade, and this year it appears to be spinning out of control.

Protectionists are focused on China because of the sheer size of the bilateral deficit with the Chinese. They export to us five times as much as we export to them. Nothing like such a ratio has been seen since the mid-1980s, when Japanese exports to the U.S. exceeded its imports from the U.S. by a factor of three, and "Japan-bashing" was in vogue in Washington....

It's hard to argue that the overall economy is suffering so much that it needs protection. A sustained slowdown has long been feared, but is yet to appear. Consumer spending is growing despite the housing market's troubles, and the unemployment rate remains historically low. So what is all the fuss about? It's probably the same old political problem that results from all economic progress. Some parts of the country are hurt by globalization even as the economy as a whole is boosted.

That's a huge point. Those who sell (certain) goods stand to gain considerably from the "bullying of protectionism"-- by imposing subtle costs on the general public. Those special interest groups have a lot of sway in a democracy which sees such uses of force is legitimate or even desirable.

For whatever reason, the Bush administration (led, as tradition decrees, by the Treasury) and the Congress (with New York Sen. Charles Schumer at the fore) are aggressively pursuing a dollar-cheapening policy, with China principally in their gun-sights. Most presidential candidates, including the Democratic front-runners, have signed on. The markets, responding to all of these political voices, are pricing the dollar lower and lower....