Having a strong currency is a good thing. A strong currency encourages foreign interests to invest in your currency as both a trade currency and a safe haven. This allows lower interest rates and less inflation. These are good for an economy.
But there are problems caused by rapidly strengthening currency. The biggest problem is trade. Let’s use the same industry example we used for the threat of deflation: vehicles.
Now, let’s say you’re going to go buy a car, and the change in currency conversion rates vs Jan 1, 2014 are unchanged from where they are today on 3/20/2015. You’ve narrowed your choices down to 3 options: a Prius, a Ford Fusion Hybrid, or a Volkswagen Jetta Hybrid.
|Number of dollars needed to purchase one unit of foreign currency.|
While it’s an absolute fantasy to pretend that 100% of the vehicle components are built in their respective countries, a hypothetical Prius built exclusively in Japan and assembled from raw materials harvested in Japan that is sold today for the exact same amount in Yen would cost 12.3% less in US dollars than it would have cost at the beginning of 2014. A similarly hypothetical Volkswagen would cost 22.3% less in US dollars than it did in Jan of 2014… Meanwhile, a hypothetical Ford would still cost exactly the same number of US dollars.
The foreign car companies have no interest in cutting their list prices. The consumer has been conditioned to expect a certain list price, and to view a reduction in price as a deal… and there’s no reason for management to not try to get as much as they can. But they can, and will, throw out whatever promotions they need to expand their market share – after all, they could discount their vehicles by thousands and still make the same profit in Yen or Euros, and their labor force is paid in Yen or Euros, their supply chain has prices negotiated in Yen or Euros, their energy, rent, debt payments, insurance, taxes, etc… are all within their own currency – to whatever extent the vehicle is manufactured within their borders. So for those manufacturers selling here within the scope of a surging dollar, they can gain higher profit by keeping their prices steady, or they can fight for more market share while still seeing higher profits by offering sales and promotions which serve to drop the price.
Meanwhile, the U.S. manufacturer must choose between keeping their profits per transaction constant and losing market share against the promotions and sales of the imports… or losing profit margins by lowering their own prices to compete.
In one case, we see the nation’s trade balance worsening, and in the other we see deflationary pressure. For those unfamiliar with the Threat of Deflation , I suggest you review what this might mean.
Of course, in the real world most cars are not 100% made in America or Germany or Japan or any given country… but rather some components are made in different countries, there’s a country of final assembly, and then there’s transportation. But every component that is made in America is now more expensive compared to components made elsewhere. Every material that is mined or refined or smelted in America is now more expensive comparable to foreign competition, and – due exclusively to the collapse in oil prices – transportation of finished goods is now far cheaper as well.
But this is based on currency, not a new development in any given industry, so every single industry will be impacted in a similar manner… and every American company will be facing the same dire choices: lose market share or lose profit margin by slashing prices… every American company that supplies a component or raw material will be facing the loss of contracts vs other nations… Every American company that sells a service that is not geologically restricted will be disadvantaged against foreign companies that sell similar services… etc.
Currently, a brief review of the trade deficit over the past 24 months is unlikely to cause much of a stir, though we’re clearly seeing a considerable growth in trade deficit:
But it’s important to remember that as a net importer, the cost of the goods that we import has been dropping – in some cases wildly. So a trade deficit would naturally drop if our balance of services and goods were maintained – as the imported goods and services would cost us less. Ergo, if our trade balance remained steady that must then represent a reduction in our market share. So the slight increase in monthly deficits shown above represents a much greater loss in the total balance of trade.
But by far, the most significant of our imports is oil, and oil prices have crashed more quickly than any other currency or commodity against the strong dollar. Furthermore, the oil market has a 1-2 year lag in the supply price elasticity, which means U.S. production of oil is still ramping up rapidly, and our net import levels are dropping even as prices are plummeting. In 2014, we more than 7 million barrels of oil per day (MMbbl/d) and were exporting an average of ~1.66 MMbbl/d. Due to rapidly rising domestic production, our average import of oil has been dropping. This has only been somewhat offset by the fact that the crashing prices of oil and petroproducts has resulted in many producers storing their product rather than exporting it, so our net export of products (mostly natural gas liquids (NGL’s) and diesel) has sharply reduced.
Here’s a review of the impact of the oil trade on the total U.S. balance of trade over the last 24 months.
If we plug these numbers back into our prior chart, we see that without the masking effect of the collapse in the oil markets, our trade deficit in all things not oil related has surged as the dollar has surged. This is not unexpected, and it will only get worse if the dollar continues to surge unchecked.
This should be enough to cause concern.
Articles that have cited this explanation:
Quit calling for the Fed to raise interest rates already!