Bush Economic Policy as Designed by Karl Rove

I’ve written about the issue of the value of the dollar a few times before, but it keeps coming up in the news. Here are some bits from a Washington Post story on the front page of today’s business section:

The Bush administration has embarked on a high-stakes effort to reduce the value of the dollar in Asia, hoping to stimulate exports and jump-start the U.S. job market but risking a sudden spike in interest rates and an eventual slide on the stock market.

…”It’s domestic politics — that’s the long and short of it,” said Daniel K. Tarullo, a Georgetown University law professor who was President Bill Clinton’s senior international economic adviser. “This is the administration’s effort to deflect attention from the hemorrhaging of manufacturing jobs from the United States by trying to place all the blame on other countries.”

It’s yet another example of how policy-making in the Bush administration is driven by short-term political concerns rather than sound long-run policies. They are facing lots of heat on manufacturing job losses. So, they have now decided to the reverse US policy of the last 10 years, which has been to say that we like a strong dollar. Their hope is to convince the US manufacturing sector that they’re trying to help. But their policy prescription is not going to work, as is typical of Bush administration economic policies, which are made by political hacks rather than economists.

Here’s why it won’t work:

The hope is that a weaker dollar will make imports into the US seem more expensive to Americans, thus reducing the importing that the US does and shrinking the trade deficit. (*) Similarly, the hope is that a weaker dollar will make US exports seem cheaper to the rest of the world, so the US can export more. This, should, according to some reasonable but incomplete logic, increase the number of jobs in the US.

The problem is that things aren’t that simple. (That’s why we international economists spend years learning how to think this sort of stuff through all the way.) There are three possible consequences of a weak dollar policy:

(1) The US buys fewer imports, and makes up the difference by domestically producing more of the goods that we used to be importing. Unfortunately, given a fixed number of factories and workers in the US at any point in time, this means we have to make less of something else. Resources are shifted away from some other types of production (such as producing US exports) into producing things that we used to import. Therefore, if this scenario happens, there’s no net increase in jobs, just a reallocation across industries.

(2) The US sells more exports, which means that production in the exporting sector goes up. Again, given how much stuff the US economy can produce in general, this means that the US will produce less of something else (such as those items that we can import instead), as resources shift into the exporting industries.

(3) The US buys fewer imports, and sells more exports. The only way this can happen is if US businesses and individuals buy less stuff — more is being exported, after all, and the US is cutting back on consumption of those goods that it imports. Both of these things mean that overall consumption and business spending in the US must fall. Lower spending means an economic slowdown. And of course, an economic slowdown means that jobs are lost, not gained.

The most likely outcome is a mix of these three, with emphasis on #3. A weaker dollar will cause some foreign investors to shift their investments from the US to other countries. This will drive up interest rates in the US, which will reduce business spending and thus slow down the economy. The ONLY WAY that the US can reduce its trade deficit is if there’s an economic slowdown. So the policy hacks in the Bush administration, while embarking on a policy intended to garner votes in the manufacturing sector, are only going to further harm the US economy. Too bad they don’t let economists run their economic policies.


(*) Think about it this way: if a bottle of Spanish wine (one of the best things in the world, btw) costs €10 in Spain, and the exchange rate is $1/€1, then it costs $10 in the US. But if the dollar gets weaker so that the exchange rate is $2/€1, then it costs $20 in the US. We would expect the US to buy less Spanish wine as a result.