The upside of a down dollar

November 11, 2010, 11:15 PM UTC

Increasing exports with a weak dollar could help the economy grow. That’s something protectionist politicians and trade negotiators shouldn’t ignore.

It’s uncertain if the Fed’s move to pump billions of dollars into the U.S. economy will give the economy the jolt it needs to get employers to start hiring more, but at least one side effect from another round of quantitative easing is clear: Don’t expect the U.S. dollar to strengthen anytime soon.

Given expectations of a sharp decline in the greenback, it’s hard not to wonder if it becomes all the more critical for the U.S. to dampen growing protectionist sentiment from politicians worried about foreign competition as the country deals with high unemployment. After all, the weaker dollar has helped the U.S. sell markedly more goods and services cheaper abroad. Although a declining dollar isn’t necessarily a good long-term strategy for economic growth, a surge in exports, at least in the short-run, could really help raise GDP.

Last week, the Fed announced plans to unleash $600 billion into the economy by buying up long-term U.S. Treasuries over the next eight months. It’s anyone’s guess if the rare and controversial move will do more harm than good for the U.S. and other leading economies, but some of the harshest critics say it won’t do much to improve America’s jobless problem. If anything, the fresh money could worsen trade tensions as officials from China, Brazil and Germany worry a fresh flood of capital inflows could hurt their own economies.

As world leaders including President Obama gather for the G-20 summit in Seoul, South Korea today, policy experts warn that protectionism is indeed a potential weapon in a so-called “currency war” — when economies simultaneously devalue their currencies in hopes of keeping exports competitive in the world market. The last time a full-on war actually broke out was during the 1930s, and what transpired was a flurry of trade barriers that ultimately reduced world trade and worsened the Great Depression. Though there haven’t been any significant barriers to trade so far, today’s situation has the potential to pan out similar to the 1930s.

In a way, the Fed’s quantitative easing strategy is in itself protectionist and has added fire to what could easily turn into a currency war. A weaker greenback shouldn’t be the only reason to keep tariffs and other trade barriers low. But if anything positive could come out of a questionable economic policy move, it’s to leverage a weaker dollar at this point and encourage trade rather than block it.

This week, a long-stalled free trade deal between the U.S. and South Korea suffered another setback. President Obama had hoped to announce an agreement while in Seoul for the G-20 summit but the two sides are still working things out. It’s uncertain why no deal was struck, but the Associated Press citing South Korea news reports said the U.S. was trying to  get Seoul to loosen regulations over emissions and auto fuel to help U.S. sales of cars to South Korea.

It’s an unfortunate setback. Who knows how low the dollar might fall, but so far the drop of its value has accelerated with the second round of quantitative easing. After reaching a one-year high on June 7, the dollar weakened 7.5% against a basket of major currencies through the end October, and a whopping 18% against the euro.

All the while, the outlook for U.S. exports looks strong as household incomes grow in emerging economics including China, India and Brazil grow. In September, U.S. exports climbed to the highest level in two years, increasing by 0.3% to $154.1 billion, the US Commerce Department reported Wednesday. This helped narrow the trade deficit by 5.3% to $44 billion.

It’s true that exports only make up about 12% of the US economy, but with GDP growth so anemic, the trend in exports might actually add to growth in the short-run.

“This is a critical time for free trade,” says James Lothian, finance professor at Fordham University’s Graduate School of Business. “The world economy has big problems and you don’t want to exacerbate them.”

So moving forward, the US could either make a bad situation worse or a bad situation a little more bearable.

See also:

Parsing the short-sighted, China bashing midterm ads

What exactly is a currency war, anyway?

QE2: Fed pulls the trigger