Plain Sense Economics

The headline in the March 9, 2009 national edition of the New York Times said, “A Rising Dollar Lifts the U.S. but Adds to the Crisis Abroad.” The article, by Peter Goodman, illustrates a fundamental action in currency exchange rates. When demand for goods or bonds or securities in one country goes up, that increases demand for that country’s currency, which puts upward pressure on the value of the currency.

What Goodman explained was that, during these tumultuous times, investors, including the government of China, are flocking to risk free investments – namely U.S. Treasury bonds. When foreigners do this, they need to convert their local currency into dollars. This increases the demand for dollars, and the value of the dollar rises on the foreign exchange markets.

(Note to budding macro-economists… This increase in the value of the dollar is different from changing values due to inflation or deflation. What we are speaking about here is how the value of the dollar compares with other world-wide currencies.)

Back to the story… the U.S. dollar has enjoyed strong results recently, largely due to this preference by world-wide investors for U.S. bonds. Here is a chart from the Wall Street Journal that compares the dollar to the Yen and the Euro.

From the beginning of the recession in December 2007, the Euro has lost almost 18 percent of its value. The Yen fell, then rose, and is now falling again. The Dollar has had some ups and downs but has grown in value fairly steadily over the last 14 months. It is now worth about 20% more than December 2007.

Now the main part of Arnold’s article was that the surge in the Dollar represents problems for the rest of the world. Part of the problem is that investment funds are flowing to U.S. bonds, instead of financing recoveries in Eastern Europe, Asia, or other parts of the globe. The other problem is that a stronger dollar makes U.S.-made goods and services more expensive to foreigners. That puts downward pressure on our exports.

One small, but relevant, group that benefits from the strong U.S. Dollar – college students going overseas on study abroad programs. Their money will go farther.