Three tales of a falling dollar
There is my own piece, Brad DeLong, and Don Boudreaux, all of which express different degrees of optimism about the current state of the dollar. Yet the approaches differ in both theory and rhetoric.
DeLong cites the near-equality of nominal interest rates
between America and Europe as an important consideration. To him this signifies that the market does
not expect the dollar to fall much further and thus that foreign investors won’t be
scared off. I believe this emphasis reflects Brad’s "upbringing" in
sticky-price open economy macro models, a’la Rudy Dornbusch and
Harvard/MIT circa the early 1980s. I never drank of that tradition
with much fervor, instead receiving the influence of Fischer Black. I don’t
expect current interest rate spreads to tell us much about future currency changes, which I view as mostly news and noise in the short to medium run. Brad is somewhat less optimistic than I because he would
start worrying if a nominal interest rate differential opened up
between the U.S. and Europe. I would tend to shrug it off, thinking
the variance of future currency movements still dwarfs the new change
in forecast.
Don Boudreaux starts with the view that having a trade deficit wasn’t bad in the first place, so getting rid of it — through a falling dollar — is no gain. For him the key is to have policies, such as free trade and low taxes, that keep America a prosperous nation. The value of the dollar will then take care of itself. I also read Don thinking that a market-generated
real exchange rate will possess Hayekian properties and pass along the
right information to investors. I am more likely to think that the value of the dollar is an accident, and more likely to think we can simply make
do with "the wrong exchange rate." I recall the strong dollar in 1985, and the weak dollar in 1988; in between not that many other things seemed to change. I conclude that when it comes to the value of the dollar it is sometimes possible to "stuff a lot into the box," and at many different angles.
Most of all, my relative economic optimism stems from a very naive look at current conditions, which do not (yet?) indicate collapse. Because of
Austrian influences and again Fischer Black, I am suspicious of long chains of reasoning, or for that matter medium-long chains
of reasoning, which imply that an apparently OK state of affairs must
end in ruin. Current market prices are indeed very noisy, but no intertemporal theory gives us better forecasts. Caution is always in order but right now equity prices and interest rates are not predicting ruin. Furthermore growth and recovery are the natural and more likely state of affairs in a relatively free economy, so I will believe in them until I see otherwise. Don, in contrast, is more
likely to worry about state interference messing up the U.S. exchange rate,
and the U.S. economy. In that sense he is potentially more pessimistic than either Brad
or I. Plus Brad and I both put some stock in the aggregate demand stimulating effect of a lower dollar, while Don doesn’t seem to.