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The Dollar Was Overvalued December 16, 2007

Posted by tkcollier in Business, Economy & Business, Geopolitics.
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Foreign Policy: Don’t Bet Against the Dollar
Fed Dollar Window Countries hold dollar assets because they want trade surpluses with the United States. According to this theory, many countries can’t generate enough domestic consumption to spur growth and full employment, forcing them to rely on exports. As the United States is the world’s largest consumer market, countries therefore have an incentive to make their goods cheaper and more competitive by undervaluing their currencies against the dollar. This obliges them to buy and hold dollars to maintain their undervalued exchange rates. The economic history of the past decade bears this theory out. Since the late 1990s, American consumers have powered a global boom, compensating for weak domestic demand in much of the world. But their massive spending on goods imported from abroad has also caused the U.S. trade deficit to balloon to $759 billion dollars in 2006, equal to 5.8 percent of U.S. GDP.

But being preoccupied with the dollar’s dominance is the wrong goal in the first place. Indeed, the policy of a “strong dollar” contributed to creating the overvalued dollar, and has always been misguided. Instead, the target should be sustainable prosperity, one requirement for which is exchange rates that prevent excessive trade deficits. This will automatically deliver a “sound dollar,” which is a better basis for a dollar standard that works. From this perspective, far from being a strike against the dollar, the appreciation of the euro is a welcome development. The Chinese yuan and Japanese yen should be allowed to appreciate as well. The next step is for U.S. policymakers to set up international arrangements to prevent future damaging exchange rate misalignments—such as the ones now being corrected.

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