Dollar Dilemma
Subject Economic Growth and the Dollar
Topic International Finance, Monetary Policy
Key Words Depreciation, Appreciation, Exchange Rate, Trade Deficit, Economic Growth
News Story

A strong dollar was supposed to be good for the American economy. According to Treasury Secretary Lawrence Summers, a strong dollar is a reflection of a strong economy and the desire of foreigners to invest their money in American companies. The inflow of foreign capital into the United States has supported productivity improvements and increased profitability of American firms. Economists are now having second thoughts about these benefits. The U.S. economy is being flooded with cheap imports leading to calls for protection especially among the steel and paper industries. Sales of agricultural products overseas are down and the nation records record trade deficits each month. The question that is now being raised is, is the dollar too high?

Some individuals believe that the dollar is well above its true value. They argue that increases in stock prices have led to a flood of speculative capital being invested in U.S. stock markets. This has fueled domestic speculative fever resulting in even higher stock prices, and even more reason for foreigners to invest their money in the U.S.

Others argue that the dollar is priced appropriately. They point to the poor performances of the Japanese and European economies. U.S. firms, according to some calculations, provide a rate of return that is 5 percent higher than European firms, and even higher than that compared with Japanese firms. Even if the dollar were a little high compared with the euro or the yen, the strong dollar has supported these economies at a time when they were faltering, by encouraging exports.

There is a third group that argues that the dollar is over-priced and is causing dangerous imbalances in the world economy. The question is what to do about it. Intervention in foreign exchange markets, lowering interest rates or raising taxes are options; however, these options are either risky or politically unpalatable. This problem may have to work itself out.

(Updated December 1, 2000)


What would happen to the value of the dollar vis--vis the yen if the Federal Reserve sold massive amounts of dollars on the foreign exchange market? What would likely happen to imports and exports?

2. What would happen to the value of the dollar vis--vis other currencies if the U.S. lowered interest rates and the other countries raised them? What would happen to the U.S. economy? The Japanese economy?
3. What would happen to the U.S. economy if the government decided to raise taxes and cut government spending? What affect would this have on the value of the dollar?
Source Steven Pearlstein, "With Strong Dollar, Questions of Stability," The Washington Post, October 18, 2000.

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