(This item originally appeared at Forbes.com on March 17, 2017.)
Recently, Harvard economist Greg Mankiw asked himself the question: “Is a ‘strong dollar’ good or bad?” Summarizing “what the president could learn from professional economists,” Mankiw, the chairman of the Council of Economic Advisors under president George W. Bush, said basically: it depends.
I feel … unenlightened.
Nevertheless, this is a reasonable question, and deserves a reasonable answer, for economic non-specialists like presidents. What the heck is a “strong dollar”? And once we figure out what it is, is it good or bad?
The phrase “strong dollar” is associated with Treasury Secretary Robert Rubin, during the first term of president Bill Clinton. It had no exact meaning, a sort of monetary “hope and change.” It mostly signified that the administration would not pursue the “easy money” cheap-dollar policies long associated with Democratic administrations going back to president Carter, president Johnson, the Roosevelt devaluation of 1933, or the pro-silver candidacy of William Jennings Bryan in 1896. Basically, the Clintonites would cooperate with the Reagan-appointed Alan Greenspan at the Federal Reserve, who was keeping the dollar roughly in line with gold at the time, a sort of dirty gold standard. Gradually increasing confidence that the dollar would not be trashed again in an attempt to solve unemployment or some other bogeyman allowed interest rates to come down during the 1990s.
A lot of people seem to think that a currency is sort of like a corporate equity, and that rising currency value represents some sort of economic virtue, in something like the way that a rising stock price suggests that good things are happening at a company. This is wrong.
A “strong” currency suggests a rising currency. A rising currency can be just as problematic as a falling one. If a falling currency introduces “inflationary” pressures in an economy, a rising one introduces “deflationary” ones. This happens whenever currencies rise in value, including Japan in the 1985-1995 period, the U.S. in 1865-1879, Britain in 1925, and in many other well-known episodes.The U.S. had more minor rising-dollar problems in 1975, 1982, 1985, 1998, and 2008.
Japan, in particular, has had a number of episodes of a rising currency since 1970. This hasn’t really been a good thing. It has been more like a loose cannon, careening back and forth and breaking things along the way.
If a currency that goes down in value is bad (“inflation”), and one that goes up is bad (“deflation”), then certainly we want one that doesn’t go either up or down, right? Then we would get that happy state where we do not molest the economy with any sort of ‘flation. This is the idea of a stable currency — one that does not go up or down in value.
Stable Money was the purpose of the gold standard, the monetary principle embraced by the United States for nearly two centuries, until 1971. Over centuries of experience, people discovered that when their money’s value was linked to gold — in the more distant past, made of gold — they didn’t suffer the problems that are caused by unstable currency value. People said that gold was like the North Star, the Monetary Polaris, the one thing in the monetary heavens that did not move, and could thus be used as a point of reference.
Probably, gold too had a bit of drift, and did not quite attain this perfect ideal. But, it was minor enough that it didn’t matter very much. Certainly, the result was much closer to this ideal of Stable Money than any floating fiat currency, whose values go up and down from first principles.
All major countries linked their currencies to gold, so that exchange rates were essentially fixed and unchanging. Currencies didn’t go up and down relative to each other.
Some governments’ commitment to reliable currency value — their link to gold — was more trustworthy than others. During the 1950s and 1960s, the U.S. dollar remained linked to gold at $35/oz., and the German mark and Japanese yen were also highly reliable. Britain and France, however, had a few devaluations. Brazil had hyperinflation.
Thus, we could say that the U.S. dollar was “stronger” — more reliable, more stable — than the French franc, or the Brazilian cruzeiro.
Today, we live in an environment of funhouse mirrors. If we choose to ignore gold as a measure of Stable Value, and do not replace it with something else to fill that role, everything starts to become rather confusing. With all currencies going up and down all the time, it is hard to tell if a change in currency exchange rates is due to the dollar going up or the euro going down. No wonder Greg Mankiw is so non-committal. If the dollar rises vs. the euro, and the euro falls vs. the dollar, which is the same thing, should we presume that it is the euro falling in value while the dollar is unchanged? In this case, to maintain a “strong dollar” — that is, a stable dollar — might mean allowing the euro to fall without following it lower. Or, should we presume that the euro is unchanged, and the dollar’s value is rising? In this case, we might want to avoid an unstable “rising dollar” by bringing dollar/euro exchange rates back into line.
Or, it could be some combination of the two, both the dollar rising and the euro falling. Maybe both the euro and dollar are falling, but the euro is falling a little bit more; or maybe both are rising, but the euro is rising a little less. If you had a room of a hundred economists, you would get two hundred answers: “on the one hand … but on the other hand …” What is a “strong dollar” in this case? What is a stable dollar?
This is one reason why our world monetary situation is a big mess, and has been a big mess since we left gold in 1971. Central bankers and academics are always swearing up and down that they are oh-so-much-better than the gold standard before 1971. Unfortunately, there is not a shred of evidence, over the last 46 years, that this is true.
A “strong” currency is one that is reliably stable in value. To achieve this, you have a basic choice: the gold standard, or the PhD standard. One has always worked. One has never worked. Guess which one is best.