Dollar strength means… remarkably little in the real world

There is no reason to suppose that other exporters will cut the price of their exports in response to the current period of dollar strength.

The sudden strengthening of the US dollar, or weakening of the Euro and yen against the US dollar, has prompted the normal amount of confused thinking in markets that such currency moves do generate. Floating exchange rate theories from beginners’ economic courses are resurrected, and two strong assertions are boldly proclaimed: the stronger dollar will boost exports from other countries to the United States and the price of imports into the United States will decline as a direct consequence of the dollar’s move.

It is pretty widely accepted by economists that these statements are just not true, excepting very extreme moves in foreign exchange markets (like that of the Russian rouble). The idea that currency strength translates into a comparable decline in import prices is a fiction that originated with the birth of floating exchange rates in 1973, and which has not in fact ever been that realistic. The reality of modern complex supply chains means that it is even less valid as an assertion today than forty years ago. Import and export prices are not generally driven by currency moves. This means that import and export volumes remain generally insensitive to currency moves.

The caveat to this (for in economics there is always a caveat) is that where a product is universally priced in single currency (the dollar, as reserve currency), then the local currency price of that product will fluctuate as the local currency changes in value against the US dollar. This caveat applies to commodities, if we can allow a relatively catholic definition of the term “commodity” so as to include standardised dollar-priced product like microchips.

There are two developed countries that have experienced significant currency depreciation against the US dollar in the recent past, and which have enough history as to dispel any idea of delayed reactions arising from short term price inelasticities; the UK and the Japan. The weakening of the pound sterling in 2008/9 was relatively abrupt, dramatic, and did not lead to a price decline in UK exports. In fact the approximately 25% decline in the value of sterling led to a 25% increase in the price of UK exports.

The key issue is that UK export prices rose in sterling terms by 25%, which is a pretty clear indication that overseas prices were held constant and the weakness of sterling was translated back into increased profit, and not increased volume. This was not some temporary aberration – six years have passed and profit has continued to trump volume.

The Japanese, rather efficiently, publish two price indices for their exports – one in yen terms, and one in terms of the currencies that they invoice in. The recent weakness of the yen has led to the former soaring, and the latter hovering around zero. The movement of Japanese export prices in yen terms is also a great deal more than the movement of Japanese export prices in contracting currency terms, suggesting that currency moves impact exporters’ profit margins more than they impact foreign currency prices of exports.