Naked Economics Wheelan, Charles (books to read for 13 year olds TXT) 📖

than it used to, then the Taurus becomes cheaper for Parisian car buyers—but Ford still brings home $25,000. It’s the best of all worlds for American exporters: cheaper prices but not lower profits!

The good news for Ford does not end there. A weak dollar makes imports more expensive for Americans. A car priced at 25,000 euros used to cost $25,000 in the United States; now it costs $31,000—not because the price of the car has gone up, but because the value of the dollar has fallen. In Toledo, the sticker price jumps on every Toyota and Mercedes, making Fords cheaper by comparison. Or Toyota and Mercedes can hold their prices steady in dollars (avoiding the hassle of restickering every car on the lot) but take fewer yen and euros back to Japan and Germany. Either way, Ford gets a competitive boost.

In general, a weak currency is good for exporters and punishing for importers. In 1992, when the U.S. dollar was relatively weak, a New York Times story began, “The declining dollar has turned the world’s wealthiest economy into the Filene’s basement of industrial countries.”4 A strong dollar has the opposite effect. In 2001, when the dollar was strong by historical standards, a Wall Street Journal headline proclaimed, “G.M. Official Says Dollar Is Too Strong for U.S. Companies.” When the Japanese yen appreciates against the dollar by a single yen, a seemingly tiny amount given that the current exchange rate is one dollar to 90 yen, Toyota’s annual operating earnings fall by $450 million.5

There is nothing inherently good or bad about a “strong” or “weak” currency relative to what PPP would predict. An undervalued currency promotes exports (and therefore the industries that produce them). At the same time, a cheap currency raises the costs of imports, which is bad for consumers. (Ironically, a weak currency can also harm exporters by making any imported inputs more expensive.) A government that deliberately keeps its currency undervalued is essentially taxing consumers of imports and subsidizing producers of exports. An overvalued currency does the opposite—making imports artificially cheap and exports less competitive with the rest of the world. Currency manipulation is like any other kind of government intervention: It may serve some constructive economic purpose—or it may divert an economy’s resources from their most efficient use. Would you support a tax that collected a significant fee on every imported good you bought and used the revenue to mail checks to firms that produce exports?

How do governments affect the strength of their currencies? At bottom, currency markets are like any other market: The exchange rate is the function of the demand for some currency relative to the supply. The most important factors affecting the relative demand for currencies are global economic forces. A country with a booming economy will often have a currency that is appreciating. Strong growth presents investment opportunities that attract capital from the rest of the world. To make these local investments (e.g., to build a manufacturing plant in Costa Rica or buy Russian stocks), foreign investors must buy the local currency first. The opposite happens when an economy is flagging. Investors take their capital somewhere else, selling the local currency on their way out.

All else equal, great demand for a country’s exports will cause its currency to appreciate. When global oil prices spike, for example, the Middle East oil producers accumulate huge quantities of dollars. (International oil sales are denominated in dollars.) When these profits are repatriated to local currency, say back to Saudi Arabia, they cause the Saudi riyal to appreciate relative to the dollar.

Higher interest rates, which can be affected in the short run by the Federal Reserve in the United States or the equivalent central bank in other countries, make a currency more valuable. All else equal, higher interest rates provide investors with a greater return on capital, which draws funds into a country. Suppose a British pound can be exchanged for a $1.50 and the real return on government bonds in both the United Kingdom and the United States is 3 percent. If the British government uses monetary policy to raise their short-term interest rates to 4 percent, American investors would be enticed to sell U.S. treasury bonds and buy British bonds. To do so, of course, they have to use the foreign exchange market to sell dollars and buy pounds. If nothing else changes in the global economy (an unlikely scenario), the increased demand for British pounds would cause the pound to appreciate relative to the dollar.

Of course, “all else equal” is a phrase that never actually applies to the global economy. Economists have an extremely poor record of predicting movements in exchange rates, in part because so many complex global phenomena are affecting the foreign exchange markets at once. For example, the U.S. economy was ground zero for the global recession that began in 2007. With the U.S. economy in such a poor state, one would have expected the dollar to depreciate relative to other major global currencies. In fact, U.S. treasury bonds are a safe place to park capital during economic turmoil. So as the financial crisis unfolded, investors from around the world “fled to safety” in U.S. treasuries, causing the U.S. dollar to appreciate despite the floundering American economy.

Countries can also enter the foreign exchange market directly, buying or selling their currencies in an effort to change their relative value, as the British government tried to do while fighting off the 1992 devaluation. Given the enormous size of the foreign exchange market—with literally trillions of dollars in currencies changing hands every day—most governments don’t have deep enough pockets to make much of a difference. As the British government and many others have learned, a currency intervention can feel like trying to warm up a cold bathtub with one spoonful of hot water at a time, particularly while speculators are doing the opposite. As the British government was buying pounds, Soros and others were selling them—effectively dumping cold water in the same tub.

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