Pegging the dollar

TYLER COWEN rounds up a number of interesting opinions on the probable impact of a declining dollar (and the probability that it may decline more yet), including his own sensible analysis in Sunday's New York Times. (There is further analysis in this week's Economist). Interestingly, around the time all of these opinons were being published, Brad Setser publically wondered whether the dollar decline, against the Euro at least, has come to an end. Mr Setser wrote on this last Friday:

I have long believed that a fall in the dollar’s real value was a necessary part of a broader adjustment needed to bring the United States’ trade deficit – and the United States need for external financing -- down. And I have long argued that unprecedented intervention to support the dollar (in order to keep other currencies from rising) by the world’s central banks has impeded this correction, storing up problems for the future.

Those basic views haven’t changed. But it also hard to deny that the dollar already has moved substantially against the euro. At 1.45-1.50, the US trade deficit with Europe should fall quite quickly, especially if Europe continues to grow even as the US slows. The US bilateral balance with Europe has already started to improve in a rather big way.

Indeed it has, and in my opinion, the better analyses of the dollar's probable path include the stabalising effect of shifting trade patterns on the dollar's value. As I noted last week, America's monthly trade deficit with Europe fell by half between July and September, and subsequent data releases will likely continue the trend.

Mr Setser today provides us with more evidence that the trade adjustment is proceeding rapidly. He cites a report explaining that European auto manufacturer Audi and its parent company Volkswagen are looking to expand their American operations based on current dollar weakness:

"[Audi CEO] Stadler told Auto Motor und Sport magazine that the dollar's weakness had forced his group to consider building a factory in the United States.

"It is not enough to turn out just a few parts like door finishings in the dollar zone; we must look at components with more added value such as the engine and transmission," Stadler explained. ... He said Audi might produce its Q7 sports utility vehicle (SUV) in the United States, which currently accounts for less than 10 percent of the car maker's total sales. ....

Audi's parent group, Volkswagen, has also said it is looking closely at a second factory in North America to complement its present plant in Puebla, Mexico.

American export growth has already begun providing a needed counterweight to negative growth pressure from the housing sector and to lagging consumer spending. Given widespread fear that contraction in business investment might be the falling domino to precipitate recession, news reports such as these must reassure experts that a floor is available for the dollar and the domestic economy, and that it might be close.

Of course, depreciation against European currencies is only one side of the adjustment coin. Questions remain regarding what effect a decoupling and appreciation of the yuan may have on the dollar and on the American economy. Still, this strikes me as reason to suspect that the worst predictions circulating regarding the dollar's decline are unfounded.