Brown and the greenback

According to the BBC, Gordon Brown today “will urge the US to set a strategy to strengthen the dollar.” This continues a long tradition of Britons making fools themselves in the US.

It’s yet another example of managerialist ideology – the idea that, whatever happens, something must be done.

It shouldn’t be. The OECD has estimated that a weak dollar has remarkably little impact on economic activity in the rest of the world. A 22.5 per cent fall in the greenback, it has calculated, would take only 0.1 per cent off euro zone output after five years – though the impact on Japan would be greater. European GDP, it estimates, would suffer more from a tightening in US fiscal policy than from a fall in the dollar.

Here are three reasons why a weak dollar has little effect:

• The price elasticity of demand for exports is low. One reason for this is that firms “price to market.” They react to a weak dollar by holding US prices down, with the result that their margins suffer, but not their volumes.
• Real wealth rises. To the extent that Europeans do pay less for American goods, they have more money to spend on other things.
• Interest rates can fall if import prices fall.

The idea that exchange rate moves have few real effects is of course well established. Before he started writing nonsense about UK pensions, Paul Krugman wrote brilliantly on this. In his Exchange Rate Instability he said:

The exchange rate has so little effect in part because it fluctuates so much. When the exchange rate is highly volatile, firms are more likely to regard its falls as temporary…[this] gives them an incentive to adopt a ‘wait and see’ policy that does not respond quickly to exchange rate changes.

I’d rather Mr Brown took the Richard Nixon view of exchange rates: “I couldn’t give a [expletive deleted] about the lira.”

That said, the weak dollar will hurt the profits of firms competing with US-based companies. But is Mr Brown really concerned about corporate profits? That would be almost as surprising as Paul Krugman and Richard Nixon having something in common.

And let’s face it. In a list of unpleasant things the Americans have inflicted on the world, a weak dollar comes very low down – certainly, lower than the Backstreet Boys or the idea that rounders is a man’s game.