The Guardian Unlimited, April 14, 2008
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By propping up the dollar, US officials are hurting lower-income workers and failing to advance the nation's economic recovery.
America's two highest-ranking economic officials, Federal Reserve Board chairman Ben Bernanke and Treasury secretary Henry Paulson, effectively declared class war last weekend. While they did not use this term, that is the implication of their stated policy of propping up the dollar.
A high dollar disproportionately benefits higher-income people to the detriment of ordinary workers, who must compete with low-paid workers in places like China and Mexico. Maintaining an over-valued dollar depresses the wages of non-college-educated workers in the same way as Nafta and other trade agreements, except that its impact is about 1,000 times larger.
The logic here is fairly straightforward. A high dollar makes goods produced in other countries cheaper for people in the US. If the dollar rises by 20% against the currencies of our trading partners, then all the goods that we import from other countries are approximately 20% cheaper for people in the US. In this way, an increase in the value of the dollar by 20% has roughly the same impact on imports as if the US government had a policy of paying a subsidy on imports equal to 20% of the sale price.
In addition, the higher dollar causes the price of our exports to rise, making them less competitive in world markets. If the dollar rises by 20%, then our exports will cost approximately 20% more to people living in other countries. This is equivalent to the government imposing a 20% tariff on exports.
There are important distributional consequences to Bernanke and Paulson's high-dollar policy because not all workers are subject to international competition. The workers who are most likely to be faced with international competition are in manufacturing. Workers in industries like autos and steel can expect to see fewer jobs and lower wages as a result of a high-dollar policy. In fact, since manufacturing disproportionately employs workers without college degrees, the downward pressure on the wages of manufacturing workers puts downward pressure on the wages of non-college-educated workers more generally.
By contrast, more highly educated workers tend to work in sectors that are protected from international competition. This is especially true of the most highly educated professionals, such as doctors, lawyers, accountants and economists. These workers will see little downward pressure on their wages as a result of a higher dollar. In fact, they are likely to benefit from a higher dollar, due to cheaper imports.
Bernanke's class war policy is made even more offensive since it shows that their bailout of Bear Stearns and the investment banks was not really about rescuing the economy - it was about bailing out Bear Stearns and the investment banks. If the economy is to recover from the recession brought on by the collapse of the housing bubble, it must substantially reduce its trade deficit, which is still running at more than a $700bn annual rate (5% of GDP).
This point is almost definitional. GDP is equal to consumption, investment, government spending and net exports. The housing bubble collapse has pushed investment through the floor (non-residential investment is also falling), and the loss of trillions of dollars of housing wealth is leading to declines in consumption. To make up for these losses, we will need either much higher budget deficits or a substantial increase in net exports (a decline in the trade deficit).
And the only way to bring the trade deficit down is to have the dollar decline further - the course of action that Bernanke and Paulson explicitly foreswore last weekend. If the country does not see substantial improvement in its trade deficit, then the recession is likely to be long and especially painful. Ordinary workers will find it much harder to find jobs, and those who do have jobs are likely to see their wages fall behind inflation due to the weak labour market.
Allowing the housing bubble to grow to such dangerous levels was a disastrous policy mistake that guaranteed the sort of economic crisis that the country is now facing. Even with good policy, there was no way that the county could avoid serious hardships. However, there was always the risk that the bad policy could make the downturn worse, as was the case with Japan following the collapse of its stock and housing bubbles in 1990s.
By committing themselves to propping up the dollar, Bernanke and Paulson are subordinating any concerns about economic recovery to their desire to protect the current distribution of income. In other words, they are going the Japan route.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.