International Political Economy the Issue

International Political Economy

The issue of whether a strong or a weak dollar is beneficial for the economy has always been a hot topic of debate between economists. The main theme of this paper is to compare and contrast the opposing viewpoints in this issue and to learn about the economic concepts that can be related to those views. On the side supporting a strong dollar policy is Dr. Lawrence Lindsey, who served as a member of George W. Bush's economic policy team. C. Fred Bergsten, a leading economist at the Institute of International Economics, is in favor of a sound dollar policy, which means that the U.S. should engage in a gradual reduction of the dollar's value so as to prevent itself from experiencing further economic troubles.

Dr. Lindsey's basic argument is as follows; he argues that a strong dollar policy would provide several benefits to the U.S. The first benefit it would receive is that as the world's foremost leader in trade relations, the U.S. should have the advantage of getting to use its own currency in international transactions. The second benefit is that the U.S. government would have seignorage, which means that at the average cost of borrowing the government would experience interest savings of up to $20 billion annually from foreign holdings of U.S. currency. America's capital markets would experience the third benefit, which is that they would be able to maintain a tight hold on receiving foreign capital from around the world. These three projected benefits help to summarize the argument of economists who favor strong dollar policy.

The argument in favor of a sound dollar policy, as explained by Bergsten, contains the following points. The first point is that the rise in the dollar's value over the years has dramatically increased the U.S. trade deficit. This has hurt U.S. manufacturers, whose exports, production, and employment have drastically suffered due to the strong dollar policy. This leads to the argument that a sound dollar policy would help to prevent the inevitable calls for protectionist measures by domestic constituencies. The second point is that this policy would help the U.S. To avoid a sudden and sharp depreciation in value or "hard landing" of the dollar, which would result in major economic troubles for the country. Along with these points, Bergsten states that the current state of the U.S. economy, which is no longer as strong as it was in the late 1990's, makes the strong dollar policy irrelevant.

When both Lindsey's and Bergsten's arguments are compared and contrasted, some important points can be derived from them. Lindsey attempts to provide reasons for a why a strong dollar policy is best for the U.S. He states that foreign investment helps to keep capital markets liquid and provides U.S. firms with sufficient capital for investment and expansion. He begins by detailing the history and impact of the U.S. dollar on the world economy. He explains about how the Bretton-Woods treaty allowed the dollar to be the dominant currency in the world.

He then goes on to explain that even though the dollar's dominance in the past could be attributed to other nations having to completely recover from the devastating impact of WWII, its dominance today could only be attributed to the confidence that foreign investors still have towards it. He fears however that this confidence will soon be lost if the dollar's dominance in the world is not maintained by the U.S.

He states that three aspects of the strong dollar policy must be implemented by the U.S. In order for the dollar to remain strong. The first aspect is that a non-inflationary monetary policy has to be enacted; this policy is supposed to prevent the dollar's purchasing power from slipping by keeping inflation at low levels.

The second aspect is that the U.S. must maintain a sound infrastructure, both physical and human, in order to continue attracting investors to America. It must maintain the sound political, legal, and constitutional framework that its society is run by. Lindsey gives an example of how the current President Bush had made the improvement of the nation's schools as one of his top priorities in office. An educated American workforce means a sound human infrastructure, which will help secure foreign investments. The third aspect Lindsey points out is that the U.S. must make sure it engages in free trade with other nations. If there is no free trade environment there is no incentive for foreigners to invest in the U.S. currency. Therefore reciprocity must be maintained between nations during trade.

In contrast to Lindsey's defense of the strong dollar policy, Bergsten attempts to attack this policy head on before defending his own. In attacking this policy, he initially points out that a strong dollar policy was useful during times of economic progress. But now that the economy has significantly slowed down, it is no longer necessary to maintain anti-inflationary measures and to lower short-term interest rates any further. He also states that some of the benefits listed by Lindsey, such as seignorage and America's ability to use its own currency during international transactions, have gone on in the past during times of both dollar weakness and strength.

Bergsten points out that the strong dollar policy has led to America's enormous trade deficit, which led to U.S. manufacturers not competing well in the global market. This could force the U.S. To create domestic safe goods, which would involve momentarily suspending certain concessions made towards promoting free trade due to its slackening economy. One other adverse effect that the strong dollar policy would ultimately have upon the U.S. economy, according to Bergsten, is that it would inevitably cause the dollar to experience a sudden depreciation in value. This would lead to a dramatic drop in interest rates and to the plummeting of the stock market, which would spell trouble for the U.S. economy.

Bergsten mentions about two aspects of the sound dollar policy that should be implemented in order for it to work, which is similar to the way Lindsey listed three aspects of his policy. The first aspect he mentions is that the U.S. And its G7 partners should influence foreign currency markets by helping to prevent both the euro and the yen from depreciating any further. This would keep the dollar in balance, thus preventing it from becoming stronger than other major currencies. The second aspect is that the U.S. And its partners could work to bring about the gradual reduction in the dollar's value so that it does not experience a "hard landing." Finally, he believes that his policy should not be labeled as a mercantilist policy because, even though it helps to endorse the manufacturing sector, it would prevent trade barriers from being set up by allowing American exports to compete effectively in world markets.