Weak Words, Strong Emotions

Black Friday isn't what it used to be. With the rise of e-commerce, retail outlets are seeing their post-Thanksgiving numbers slide. At least I blame e-commerce (especially since now we have "Cyber Monday") but others are blaming a sliding economy, in part sparked by Wal-Mart's lackluster numbers.

There's a sick sort of temptation for people in the media to cry wolf, especially since so many people never learn (unlike the villagers in the story). So its not surprising there was concerned talk on the radio today about weak dollar and, briefly, the trade deficit. Time for a lesson.

First, a "weak dollar" isn't bad for everyone. A weak dollar means American goods are cheaper overseas and boosts exports. Now it's true that the strength of a currency can indicate the strength of the economy (if the economy is great, lots of people want to due business there which means they need the currency). This is a pretty good proxy but only if the currency is weak or strong for very long time. In the short run, there is error and there is noise. And because traders won't want to take chances there's downward bias (and also thanks to media panic). Note that the dollar dropped after Wal-Mart reported its sales, as if Wal-Mart is the entire economy. In short, the dollar tells us a few things but only in the long run. The changing prices offer new opportunities so let's give the market a chance to respond. That's the real measure of a good economy.

Second, a "trade deficit" is even more immaterial than a "weak dollar." Unlike the budget deficit, the trade deficit is not debt. We don't have to pay it back in any way, shape or form. It is merely an arbitrary distinction between net capital flows (the level of foreign investment in the US) and net exports. By definition, if there's a trade "deficit" then there exists an inflow of capital. The more we import, the more American money exists elsewhere and since the US is the only place to legally spend that money (except for some small countries such as Panama and the Northern Mariana Islands), that money ends up back here. Sometimes it is imports, sometimes it is the buying of American assets (often it is Federal debt).

Now here's the interesting bit. By combining these two panic buttons, things seem even less bad. A weak dollar discourages importing and encourages exporting. It also discourages Americans investing abroad and encourages foreigners to invest in America. (Note they are both moving in the same direction because America's stuff is cheaper, which is why the distinction is truly arbitrary.) The point is both of these things strengthen the American dollar. It's hard to tell what the trade balance sheet will look like but as I (hopefully) illustrated, that doesn't really matter.