A Weak Dollar Hurts Before It Helps


By Michael J. Mandel One of the drawbacks of conventional wisdom is the frequency with which it's just plain wrong. Everybody "knows" that a falling dollar will boost the economy by making exports cheaper and imports pricier. The result is supposed to be more jobs and higher profits as well as a quick revival of growth. So as the dollar sinks against the euro and the yen, we all breathe a collective sigh of relief (see BW Online, 5/16/03, "Good News! The Dollar Is Down").

How quickly we forget. Economic theory and the experience of the 1980s tell a different story: A falling dollar, at least for the first year or two, is like a deflationary tax. It takes time for consumers and businesses, both in the U.S. and abroad, to adjust their buying behavior. Until then, money is simply sucked out the door in the form of higher import prices, just as if oil prices had spiked and stayed high. The result: A weaker dollar depresses real wages and profits in the near term and makes a robust recovery even more unlikely anytime soon.

COSTLIER SHOES. Of course, that doesn't mean everyone is hurt by a falling dollar. Companies with big overseas sales, such as McDonald's (MCD), are happy to trumpet the benefits of a weaker dollar. Such companies can immediately translate their foreign earnings in euro or yen into a plumper bottom line in dollars, even if those overseas profits are never brought home. Other companies, facing direct competition from overseas rivals, gain pricing power. And eventually, a year or two down the line, the weaker dollar yields wider benefits, boosting exports and cutting imports.

But for the immediate future, the effect of a declining currency will be negative. Consumers will pay more for imported shoes, VCRs, cars, and other goods, and have less money for other purchases. Similarly, rising costs will hurt earnings at many businesses that rely on imported raw materials and parts -- an increasingly large group in an era of global supply chains. Retailers, especially, will find themselves in a double bind since they'll have to pay higher prices to stock their shelves with imported goods even as their customers are increasingly cash-strapped.

Perhaps most distressingly, the weaker dollar could turn out to be a drag on business investment. With the exception of autos and trucks, imported capital goods account for about 40% of business spending on new equipment. That means a drop in the dollar could push up prices for capital goods, discouraging capital spending by companies. That isn't the outcome we want if we are looking to continue the productivity gains of the 1990s.

WATCH THE "J-CURVE." The experience of the last big devaluation, in the mid-1980s, doesn't leave much room for optimism. The dollar peaked in the first quarter of 1985 and then fell by almost 20%, on a trade-weighted basis, over the next two years. More strikingly, the dollar fell 40% against the yen over that period.

This sharp decline helped the profits and stock prices of a few large exporters, such as Caterpillar (CAT), while auto, steel, and tech companies got a bit more relief from foreign competition. But the economy as a whole suffered. The dollar value of goods imports soared 20% from the first quarter of 1985 to the first quarter of 1987, while the dollar value of exports rose by only 4%. This is what economists sometimes call the "J-curve" effect -- at first, the trade balance gets worse when the dollar declines and only improves later on.

Over those two years, higher prices for imports were reflected in falling incomes for many Americans. Real pay for production and nonsupervisory workers dropped, as did corporate operating profits, according to the Bureau of Economic Analysis. The dollar drop didn't even do much to protect manufacturing jobs. Factory employment fell by almost 600,000 jobs, vs. a 1.4 million rise over the previous two years. It wasn't until the mid-1987 that the U.S. began to feel the positive impact on exports and manufacturing jobs.

FEW REPLACEMENTS. The initial effect of a plunging dollar could be even worse this time. Goods imports are about 12% of gross domestic product, vs. 8% in the mid-1980s. So the U.S. will be hit harder when import prices go up. And much more of production is now outsourced abroad, so it's even trickier to find domestic replacements for a wide array of products.

It might not be possible for Washington to stem the dollar's slide even if it wanted to. In any case, over the next couple of years, that decline risks making Americans poorer, not richer. Mandel covers the economy for BusinessWeek from New York


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