Dollar Hits New Highs, Wreaking Havoc on US & World Economy


By Jeff Ferry, Coalition for a Prosperous America (CPA)

Sep 12, 2022


The foreign exchange value of the U.S. dollar is soaring on an almost daily basis, causing problems here at home and abroad. There is growing talk of international coordination to stem the rise of the dollar and bring more stability to currency markets. Meanwhile there is support in Congress for the CPA proposal of a Market Access Charge to moderate the flood of incoming capital flows and move the dollar back down towards a more competitive level.


So far, Biden administration officials are like the three monkeys: they see nothing, hear nothing, and say nothing. But the pressure to act may soon become irresistible.


Since the start of this year, the dollar has risen 7.4% on a trade-weighted basis (see Figure 1 below). Against selected other currencies, it has risen much more. It has risen 21.5% against the yen and 12.6% against the euro (see Figure 2).


The surging value of the dollar has nothing to do with fundamental economic forces. It is all driven by capital movements which are responding to two things: first, the dislocations in the world economy caused by the Russia-Ukraine war, and secondly, central bank interest rate policies to fight inflation.


The Russia-Ukraine war led directly to the shortages of natural gas in Europe and the skyrocketing global price for oil and natural gas. The spot price in Europe for natural gas has roughly tripled since January, leading to double or triple digit increases in the cost of electricity for European households and businesses. The higher cost of importing gas and oil will lead to deterioration in the balance of trade for European nations, and many other oil importers too, such as Japan. This energy shock is likely to cause a recession in many parts of the world. The weaker balance of payments is putting downward pressure on the currencies of many oil-importing nations.


Meanwhile, the U.S. Federal Reserve is raising interest rates to fight the inflation that began last year and was running at 8.5% as of last month. After three interest rate increases earlier this year, the Fed is likely to hoist rates by another three quarters of a point at its next meeting later this month. Other nations are also raising their interest rates, but in most cases by not as much as the Fed is raising U.S. rates.


The widening interest rate differential makes it more attractive for investors to hold U.S. assets, such as Treasury bonds. Demand for U.S. assets, in other words capital flows into the U.S., raise the foreign exchange price of the U.S. dollar. But on top of that, international investors increasingly believe that any U.S. recession is likely to be less severe than recessions in Europe or elsewhere. This makes U.S. equities more attractive than foreign equities and equities account for roughly half of the capital flows in and out of the U.S.


In January of this year, the U.S. dollar was already some 17% overvalued, according to a study we carried out back then using standard Peterson methodology[1] for estimating fundamental equilibrium exchange rates. Against specific currencies, the dollar was far more overvalued. For example, it was 22% overvalued against the Chinese yuan and 40% overvalued against the Japanese yen. This yearís rise in the dollarís value only makes the problem worse. It is a fundamental principle of economics that an exchange rate should be set at a level that enables a nationís trade to balance, in other words exports and imports should be roughly equal or trending in that direction. The U.S. has not seen such a balance in more than 45 years, definitive evidence that the U.S. dollar has been overvalued for decades.


The overvalued dollar is a huge problem for U.S. manufacturers and farmers. It is one of the prime causes of escalating U.S. imports, which, at $2 trillion in just six months, are running 23% higher than last yearís imports at the half-year, despite the fact that our economy is roughly flat this year.


The scale of the problem is clear if we look at dollar overvaluation as a tax on domestic producers and a subsidy to importers. A global overvaluation of 24.5% (Januaryís 17% plus this yearís 7.5%) is equivalent to a subsidy worth $980 billion on this yearís imports which are on track to reach $4 trillion. Itís also a handicap on our roughly $3 trillion of exports this year, worth about $735 billion, for a total handicap on U.S. production of $1.72 trillion.


Compare that to total U.S. tariff revenue this year which is likely to be around $110 billion. The benefit to importers from the overvalued dollar is 15 times more valuable than the small handicap of the tariffs.


We can make the same analysis about bilateral trade with China. The U.S. has run its largest bilateral goods deficit with China for years, and this yearís China imports are on track to reach a record $586 billion, as we calculated in this recent analysis. With U.S exports to China likely to reach $144 billion, the two-way trade flow is worth some $730 billion. Our overvaluation with respect to the Chinese yuan was 22% at the start of this year. As Figure 3 shows, the Chinese government held the yuan stable around 6.33 to the dollar for the first four months of this year. However in April, either because of weakness in Chinaís domestic economy or because of the upward trend in the dollar, the Peopleís Bank of China took a decision to allow the yuan to fall. It has fallen steadily since then, to close to 7 yuan to the dollar, a decline of some 9.5%.


So as of today, the yuan is about 31% undervalued compared to the dollar. That is a benefit to China worth some $226 billion on this yearís bilateral trade. Our Section 301 tariffs on China are running at some $50 billion a year, so the currency benefit is worth more than four times the value of the tariff handicap on Chinaís imports. None of these calculations include U.S. de minimis imports from China, which we have estimated at an additional $145 billion a year...


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