Atlantic’s commentary on US Presidential candidate Mitt Romney’s speech in Poland highlights the conventional wisdom: de-value the currency, support manufacturing and get back to sustainable, long term growth. The problem, as the last 12 years have shown, is that it’s a short-term policy not a long term policy. Utilised as long-term policy it has failed.
I certainly understand the short-term rationale. A cyclical downturn sees domestic demand decrease, a falling currency leads to greater demand for an economy’s exports, which replaces some lost domestic demand and the economy makes a cyclical recovery. But it is not a structural growth story; you can’t grow an economy by making households (70% of the economy) poorer.
Over the last twelve years the excessively loose monetary policy of successive US Federal Reserve governors has seen the US$ depreciate, on average, by about 12% relative to the levels seen in the previous ten years back to 1992. This weak dollar policy has fundamentally weakened the purchasing power of US household incomes with the consequence of weak, below potential economic growth. Growth in the 10 years to 2002 averaged 3.4% compared to 1.6% in the 10 years to 2012. Even in the boom years, the strong dollar 1990s outperformed the weak dollar 2000s. Indeed, it was only the perception of wealth, created by lower long-term interest rates that saved the 2000s.
A strong dollar policy would quickly return the US to a sustainable and strong growth path.
As I explained in a recent post : growth in services reflects a growth in wealth. Every person on the planet participates in the economy to either increase the time they have on the planet or the (perceived) quality of that time. As we grow wealthier, there are diminishing marginal returns from goods to our happiness and we rely more on employing others to create extra or better time for ourselves. By becoming poorer, however, our demand for services must diminish.
The dollar weakness has contributed to a greater than 40% increase in US import prices with the impact of diminishing purchasing power for households. In comparison, Australian households, who tend to have similar spending habits (we’re nearly as obese and we have a similar reliance on stuff stamped with Made in China) have seen a 10% FALL in import prices over the same period. Dollar weakness should be combined with higher trade barriers in the US seen in greater WTO activism (USA v Australia). At a time of weak income growth, dollar weakness and so much higher import prices must have contributed to a feeling (and probably a reality) that US households have gone backwards in the last decade.
This weak income growth (a combination of low wage growth and high unemployment) is, ultimately, deflationary in a services-based economy. Rising essential living costs (mainly commodities with globally set prices referenced in weakening US dollars) squeeze out services consumption which in turn sees weaker employment growth and a deflationary spiral. Services are generally less essential and so the first to be cut from households budgets, but generally contribute more to our perceptions of greater welfare and employ considerably more people.
As the price of food, energy and clothing rises, households spend less on services. They start to do their own chores, eat-in and spend more time at home. They do their own taxes, mow their own lawn, paint their own house and probably self-diagnose via the internet. By avoiding paying for such tasks they directly contribute to lower incomes. The services sector has much less sticky wages. Wages are more likely to be hourly or piece-rate based. Tips play an important role in income. There are less unions and less annualised contracts. A deflationary spiral sets in.
As Bernanke and the rest of the FOMC survey the American economy they see weak activity and price growth and are tempted to undertake more monetary stimulus. This is an incorrect diagnosis of the situation. It is the very policy they are considering as remedial that is contributing to the need for remedy.
A strong dollar would amend this situation. Households would see increased purchasing power. They could save more and re-build their battered balance sheets. Soon they would be out employing fellow Americans to help them, create more time for themselves and so, live richer lives because they’d be doing more of what they want to do. Time would become less scarce.
This can be the only solution for a US recovery. To maintain current dollar weakness is absurd. One day there will be a recovery with rising interest rates and a stronger dollar. Such a recovery will initially seem weak as as manufacturers lay-off their workers in the face of weaker price competitiveness. But it is the only sustainable way. Ultimately, the main comparative advantage of a US citizen is providing services to their fellow Americans in the richest consumer market in the world.
Making a nation poorer does not lead to strength in the long term; particularly in a services economy. The US is not Poland, it’s still much, much richer.