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Some Swords Have Just One Edge

Some Swords Have Just One Edge

As the dollar continues its decline, today falling to yet another record low against the euro, public attention is now being focused largely on how the trend will be harmful to Asia an Europe and beneficial to America. Media analysts have described the euro as “bearing the brunt of the dollar’s decline,” implying that a strengthening currency is a burden to be suffered, while a weakening currency a benefit to be enjoyed. To such analysts, the down side of the dollar’s decline is limited to increasing costs for US travelers planning European vacations. The reality is that the dollar’s decline does not cut both ways, it is simply a single edged sword held to the neck of the U.S. economy.

This morning, Steve Liesman, CNBC’s senior economics reporter, downplayed the risks of a falling dollar by likening those concerned to “Chicken Littles.??? His position was supported on-air by a guest Wall Street analyst (whose name I did not catch), who in the economic equivalent of fashioning a silk purse from a sow’s ear, offered three alleged benefits of a falling dollar; 1) higher earnings for U.S. multinationals, 2) making U.S. assets more attractive to foreign buyers, 3) weaning foreign producers from their dependence on American consumers.

First, while it may be true that a falling dollar initially raises the nominal value of the foreign earnings generated by US corporations, the real value of those earnings remains the same. After all, is there really a benefit to earning more dollars of diminished value? For exporters, a falling dollar amounts to nothing more than a price cut, with any increased earnings merely an illusion. Eventually a lower dollar leads to rising domestic production costs, ultimately further reducing the real value of their earnings. In the meantime, those higher nominal earnings are of diminished value to shareholders, as the dividends they support buy fewer products and ultimately deliver reduced purchasing power.

Second, while the falling value of the dollar does indeed reduce the price of U.S. assets, it initially diminishes their appeal. Foreign buyers may become fearful that future dollar declines will undermine returns, while current holders of U.S. assets may decide to sell to avoid more substantial losses down the road. However, once foreigners feel the dollar’s decline is largely over, they may indeed undertake a bargain-basement shopping spree. But this will hardly be a good thing for America.

Take the example of Procter & Gamble, which currently trades for about $54 per share, or the equivalent of 41 euros. Assume the dollar loses 50% of its value against the euro, reducing the euro price of P&G to 21. If, as a result, a European company decides to buy P&G for 25 euros (a 20% premium), requiring payment of $65 per share, would this be a positive development for Americans? Are they better off selling an asset for 25 euros that used to be worth 41? Is America better off with Proctor and Gamble owned by Europeans, with profits formerly earned in America flowing to Europe?

Finally, the analogy of weaning foreign producers from their dependence on American consumers confuses the roles of the two parties, and the vastly different implications for each once the relationship ends. Ultimately it is American consumers who must be weaned from their reliance on foreign producers. While this inevitable development is necessary to restore America’s economic viability, it will involve considerable short-term pain for Americans, who will suffer dramatically reduced standards of living. Foreign producers, on the other hand, once they stop the economic equivalent of breast feeding non-productive American consumers, will enjoy higher living standards. This is because scarce resources, formally devoted to meeting the needs of Americans, will be freed up to satisfy their own needs and desirers.

By downplaying the risks of a falling dollar both Wall Street and the media are doing the public an incredible disservice. Not only may they succeed in discouraging some investors from taking necessary actions to protect themselves, but they ultimately compromise their objectivity, and diminish their creditability.

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