Conventional thinking says that a weak currency should boost the economy via promoting exports.
But the Wall Street Journal Blog argues otherwise. (bold highlights mine)
The financial markets are focused on how nations, including the U.S., would prefer weaker currencies in order to make their exports cheaper on global markets. Indeed, multinational companies Caterpillar and McDonald’s reported Thursday that their bottom lines benefited from stronger international sales.
The flip side of that weak-currency strategy, however, is that imports into the U.S. become more expensive. If so, that will be a problem for millions of companies that don’t have an export presence. These companies, especially small and medium-sized firms, will see their profit margins squeezed because of higher costs…
Michael Trebing, senior economist who oversees the survey at the Philly Fed, says that in the past, respondents have said the prices-received index is weak because of competition and the inability of businesses to pass along cost increases. As a result, profitability is under attack.
“Accounting 101 tells us that if a company’s input costs go up, and they are unable or unwilling to pass those costs on to the consumer, their margins get squeezed,” says Dan Greenhaus, chief economic strategist at Miller Tabak.
The squeeze could get worse as import prices adjust to a weaker dollar because U.S. business depends on imported supplies. Excluding energy commodities, industrial materials and supplies account for 14% of all U.S. imports. In the first eight months of 2010, nominal shipments of these imports increased 30% compared with the same period in 2009.
To be sure, many global contracts are priced in U.S. dollars. But as the dollar weakens, foreign producers themselves will soon come under margin pressure when the dollars are translated into local currency. Over time, new contracts will carry higher prices for the components and materials that are important inputs for U.S. manufacturers and service-providers.
In one respect, higher import prices would please the Fed because bank officials want to see overall U.S. inflation head higher.
Exports make up only 12% of the US economy (above chart) compared to imports at 17% (below chart)
A weak dollar policy not only punishes imports, which ironically represents a much larger component of the US economy, importantly, it would hurt domestic trade which comprises 76% of the GDP.
So when Fed officials say they would like to see higher inflation through a weaker currency, they are simply implying that exporters should be subsidized, shouldered by the rest of the economy, at the cost of vastly lowered standard of living through higher consumer prices.
Of course, as mentioned above, instead of adding jobs, a profit squeeze on domestic non-export enterprises, through higher prices of inputs, would translate to high unemployment.
And an environment of high prices and stagnating economy is called stagflation, a dynamic the US had encountered during the 70s to the 80s.
Yet that’s how ‘subtle’ protectionism works, the rhetoric and ‘noble’ intentions depart from real events, where a few politically handpicked winners would emerge at the cost of everyone else.
Update: I forgot to add: There is another unstated beneficiary here, i.e. holders of financial assets. And the sector that requires an asset boost is no more than the banking sector, which have been severely distressed by the recent crisis. And this is why I think that a weak dollar isn't directed mainly at bolstering exports but to keep the banking system afloat.
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