commissioner.org
| Source | Ulhas Joglekar |
| Date | 02/06/15/01:43 |
| The Economic Times
Friday, June 14, 2002 Leave the dollar alone Joseph Stiglitz IT is always risky to write about exchange rates. If a currency's exchange rate is falling, it may well be rising by the time one's article appears. But the issue of how we should think about exchange rates and their appropriate management is a perennial one. So what is at issue now is not just the falling dollar, but rather what US officials intend to do about it. Paul O'Neill, the outspoken US treasury secretary, suggests that there is little the US could or would do to sustain the dollar. His remarks were criticised by some as abandoning the strong dollar policy that was the Clinton Administration's hallmark. One responsibility of economic leadership is to dispel economic myths - certainly not to create them. The "strong dollar" policy represents an especially egregious example of an economic myth; it seems to suggest that the US treasury could, and would, maintain the strong dollar, and that a strong dollar is good for the US. When I was chairman of the President's council of economic advisers, I was often asked if I supported the strong dollar policy. I replied that I believed in an "equilibrium dollar." In other words, exchange rates are no different from other prices. Like the price of apples and oranges, market forces should determine them. Anyone who says he believes in a "strong orange policy" would be ridiculed. Yet some of those who seem to have the greatest faith in market forces treat exchange rates as if they were governed by laws other than those of standard economics, so that a word or even a look from a finance minister could lead currencies to soar or plummet. Of course, there is considerable irrationality in currency markets. Keynes once described asset markets as beauty contests, in which the objective is not to ascertain who is the most beautiful person, but whom others will think is the most beautiful. The objective in currency markets is, indeed, often to guess what others will be thinking. But even if government intervention can affect exchange rates in the short run, in the longer run, it is market fundamentals that matter. There may be a legitimate role for government in limiting excessive volatility, but if underlying economic fundamentals do not drive the exchange rate, what is the basis of our confidence in the market system? Belief in misguided notions inevitably leads to further nonsense. On one occasion, a reporter queried the US treasury on the adverse effects of the strong dollar on exports (at the time, car sales and other exports were suffering.) The response was that the strong dollar meant a strong economy, and a strong economy strengthens the ability to export. But of course, even the US treasury, as powerful as it may be, cannot repeal the laws of economics. Demand curves are downward sloping: typically, at higher prices, others will demand less of Americana goods, and a strong dollar means that American goods are more expensive. Perhaps the most important objection to the strong dollar policy is that it encourages precisely this confusion between a strong dollar and a strong economy. We should no more be emotionally attached to the exchange rate than to any other price. A stronger exchange rate discourages exports, and when an economy is facing rising unemployment, it can make a bad situation worse. On the other hand, a higher exchange rate may also lead to lower inflation, as import prices fall. When inflation is the primary concern, a strong exchange rate may be good for the economy. The strong dollar policy reeks of an economic nationalism that is out of step with the era of globalisation. If the dollar is strong, then the euro or the yen is weak. But how are political and economic leaders in other countries to respond? Should they simply agree to the strong dollar policy, even though it implies a weak yen or euro policy? What is required is a debate with the US, for the strong dollar has led to an anomalous situation: the world's richest country seems unable to live within its means and must continually borrow hundreds of billions of dollars from abroad to finance its huge trade deficits. The strong dollar - far more than Japanese protectionism - fuelled the bilateral deficit with Japan. It also contributed to protectionism at home, reflected in the new US steel tariffs. It is high time that the nonsense of the strong dollar policy be laid to rest. Paul O'Neill should be commended for helping in this effort. Perhaps we can now begin to think more seriously about creating an international economic system that acknowledges the devastating effects that market volatility among major currencies has on less developed countries, and that ensures greater stability. For too long, we have blamed the victims. That has merely permitted us to avoid taking a hard look at the system itself. (The author is professor of economics and finance at Columbia University, the winner of the 2001 Nobel Prize in Economics. Copyright: Project Syndicate, June 2002) Copyright © 2002 Times Internet Limited. All rights reserved. |
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