Exchange Rate Arguments and Cognitive Dissonance

A while back I had an argument with my flatmate about how the quality of the content in The Economist has gotten worse. I used to enjoy their writings a lot, and it definitely contributed to my decision of pursuing an economics degree. A few years ago, when my understanding of economics was basically non-existent, their authoritative writings was simply mind-blowing. Epic. Such a good education, and I read their articles as often as I could. Nowadays, I increasingly find their stories bouncing between implausible, boring and superficial. Of course, my knowledge has multiplied and I am hence no longer their prime audience. Nevertheless, you would expect a much higher standard.

For instance, this week's cover story was about how a strong dollar is bad for the rest of the world. The argument? 3 childishly naive points: 

1. when the dollar surged during Reagan's first term, and U.S. (like today) had large government deficits, the rest of the world had troubles – no explanations, details or evidence. 
2. The dollar-wave rides on expectations of Trump infrastructure spending/tax cuts, but the President-elect has also promised protectionism, and that protectionism is gonna hurt us all – believable as that scenario is, that's a reason for why Trump would be bad for the rest of the world, not why a strong dollar would be. 
3. Overseas debt denominated in dollars (some $10tn) gets more difficult to service, and so an appreciating dollar will cause credit contractions in Turkey or Brazil or Mozambique, especially since those countries have pyramided credit on those borrowed dollars. 

The first two are not even arguments, whereas the third has a plausible ring to it. Sure, if the dollar increases in value against other currencies ("appreciate" in econ-lingo), paying off debts in dollar with now-weaker currencies will get slightly more difficult. 

There are two major problems here, however. First, doesn't naive introductory macro courses tell us that depreciating currencies are good for countries below full employment, because their net exports now increase and boost their economies? (Remember, a depreciating home currency is the corollary of an appreciating foreign currency; so if the dollar is strengthening as The Economist argues, that is the same thing as other currencies weakening). Hasn't The Economist themselves been running that story over and over and over? In January this year, for example, they were telling us all how a depreciating euro would be good for the eurozone, since their goods were now cheaper for foreigners to buy; hurray, Y = C + I + G + NX! Go, weaker euro! But ten months later a stronger dollar (=weaker euro) is bad for the rest of the world (the eurozone included)...?

Second, dollar-denominated debt are hardly the only thing in the hands of non-Americans. They also hold... *drumsticks*... assets! Two quick googlings give me that about 16% of the U.S. stock market is owned by foreigners (amounting to some ~$3tn), not to mention the ~$6.5tn or so of the U.S. government debt held by foreigners. Together, those two data points alone basically offset the entire argument. 

Somehow, the cognitive dissonance here managed to escape the editors: a weaker currency is mechanistically beneficial, unless we're considering debt. But we forgot to consider debt when we were praising a weak Euro in January, and this week our entire case for why a strong dollar is bad hinges on considering debts – but intentionally excluding assets!

The point I'm making isn't that certain magazines need new editors (though you might think so when the entire case of their cover story is made redundant by twenty seconds on google...) It's the more general point I have been getting at lately; many more things impact economic outcomes than simple second-year-econ mechanic stories of exchange rates or interest rates. Debt matters, agents' responses matters, changing expectations matters, change itself happens unexpectedly. In this case, the argument of whether a strong dollar harms the rest of the world hinges not only on the productive capabilities of the rest of the world or firms' pricing reactions, but on American consumers' elasticities, on debts and asset holdings across the world, on what part of those debts/assets are denominated in dollars and basically every other thing under the sun. 

A little more humility. And a little more understanding that economic consequences are more complicated than mechanistic introductory macro, please.