Devalued?

The dollar recently reached a near record low in comparison to the euro. So much for the U.S. Economy; all good things must end. Or not. The news loves scary-sounding stories, but a little depreciation can actually help the economy...

So how in the world can depreciation help the economy? It means the dollar is losing value! We're getting poorer compared to other nations without spending a dime. Other countries want more of our funny pieces of paper before handing over their electronics and oil.

Sure, if the exchange rate rises it's harder to afford imports. But the converse also holds: more foreigners can buy our exports. Say I run an American widget manufacturer and my product sells for $60. If the exchange rate is 1 $/€, my product sells for €60. But should the dollar fall to 1.5 $/€, then my product sells for €40. So does this actually work in practice? Just recall how China artificially held their currency low stimulating growth.

Outsourcing is considered a complaint worthy subject. American companies send work abroad where people will accept less in wages. So what happens when the dollar loses value here? Should the exchange rate go from 1 $/€ to 1.5 $/€ that $50 worth of labor now costs you $75. Maybe those domestic workers are cheaper to hire now. And the same logic applies to goods: the domestically produced becomes cheaper compared to the imports. Good news for the local businesses.

For my next trick, you'll need a rough idea how exchange rates are determined: In any country there are various investment opportunities with some rate of return (these are reflected by the interest rate). If the return on investments is higher in one country than another, investors will want to place their money there. So if German bonds offer good returns, foreign investors will start buying them up. But you can't pay for German bonds in dollars, you need euros. So there will be a large demand for euros, which drives up the price, and the price of a euro is simply the exchange rate.

So what does this mean? For one, if the dollar is depreciated it means the interest rates are low--the perfect time if you need a loan (both for personal needs, and for businesses to expand). Also you can easily see that the political parties are neither to be blamed or congratulated: the interest rates are the domain of the FED and the banking system.

There are downsides to the fall in the dollar. Obviously, the converse of the above statements is true: we have to pay more for our imports. The cost of foreign labor and materials increases the price of some goods. Domestic investments are yielding lower returns. Even foreign countries can be hurt: U.S. Investments in foreign countries don't go as far and the same is true of foreign aid.

The world of economics is a weird place, few things seem right: a little inflation is healthy and deflation terrible; a greatly productive nation can profitably trade with a nation inferior in every way; a single dollar saved in the bank can create ten dollars of new spending; a trade deficit can boost domestic businesses. The talking heads are trained to talk about, not understand the world. Understand, and the news stations become pure entertainment.