Offshoring — why the powers that be won’t stop the dollar’s decline

I first started this post on January 10, 2005. At the time the dollar was in decline, George W. Bush was president, and there was much concern in the country about the decline of the dollar.

The concern was the the US appeared to be loosing its “leadership position” and the weaker dollar was making oil and other imports more expensive. There were calls to the administration to take steps to make the dollar stronger. This is very relevant today, when the proposed Quantitaive Easing 2 (a.k.a QE2) will likely have the effect of making the dollar weaker. The US is also pressuring China to revalue the Yuan. The US claims that the Chinese government “pegs” the value of the Chinese currency to the dollar, making Chinese goods artificially cheap in the US, and US goods expensive in China.

Back in 2005, I thought through the implications of a weaker dollar and wondered whether the administration would in fact do anything to make the dollar stronger. For example, one thing could be to increase the inerest rates that the Fed charges. But when I thought it through, I decided that most likely the administration would do nothing to strengthen the dollar.

A weak dollar reduces outsourcing, oil consumption and imports. A weaker dollar also helps increase exports, so the combination of fewer imports and more exports helps with the trade deficit. This is how it goes:

Outsourcing: The company I worked for at the time was a US based company with global operations. Department’s budgets were allocated in dollars. As the dollar dropped against currencies like the Euro and the Rupee, employees overseas became more expensive. So a falling dollar discourages  US companies from offshoring jobs. At the same time it can encourage foreign companies to set up shop in the US. At the time I heard of doctors’ groups in India getting radiologists in the US to analyze X-rays. X-rays were sent to them electronically, and they electronically filed reports for doctors in India.

Oil Consumption: One of the things in the news in 2005 was rising gas prices. The price of crude oil is measured in US dollars. As the US$ fell, the price of crude went up. This in turn pushed up gas prices. Which in turn made people drive less, and think of getting more fuel efficient cars.

Trade Deficit: Finally, all those cute Barbie dolls and other stuff we buy from abroad were getting more expensive. At the same time US exports (cars, planes, heavy machinery, corn, soy etc.,) were getting cheaper in those other countries. This helped us export more, while at the same time we bought less from abroad. Very good for reducing the trade deficit.

Given all these effects, I couldn’t see the US government doing anything to strengthen the dollar. Now we are back where we were 5 years ago. and with QE2, the Fed is being accused of intentionally weakening the dollar to gain an economic advantage over other countries, something they deny.