Question: Most international trade contracts are priced and settled in dollars. Doesn't that make the dollar's exchange rate irrelevant?
Quick Answer: No. International prices for U.S. exports may be expressed in dollars, but they are determined in competition with similar products from other countries at current market exchange rates. If the dollar is overvalued, the price of U.S. products may be too high to compete with similar products from other countries.
Discussion: A common reason that many Americans think the dollar does not need to be devalued is that the price of made-in-America goods are always expressed in dollars in everything we read.
For made-in-America goods sold within the United States,
this makes perfectly good sense because the dollar is the common currency of producers
and consumers. However, made-in-America goods sold as exports are also commonly
priced in dollars, and this is where the confusion starts. Before getting into the complexities of crop prices, let's start with a simple example to illustrate the point - hammers.
The Case of Hammers: What is the "world price" of a hammer that you buy at
the hardware store? A U.S. producer might produce one for $20, but a producer
in China might produce an identical one for RMB 120 including shipment to
America. If the exchange rate is RMB 6 per USD, the Chinese and American
hammers will compete head-to-head with both priced at $20. That becomes the
world price.
But if the exchange rate is RMB 7 per USD, the hammer priced
at RMB 120 from China will only cost about $17 in the United States. Therefore,
to compete, the U.S. producer must cut his profits or even take a loss so that
he can sell his hammer that cost $20 for $17 – the "China Price" in
the U.S.
Our imaginary hammers must be priced at $17 or less because this is the world price and hammers will be invoiced and paid for at $17. However, though expressed
in dollars, the hammer's price in this simple example is actually determined by the RMB price of the hammer produced in China, converted to dollars at the prevailing exchange rate. The prevailing market exchange rate thus plays an important role in determining the world price.
Now let's take a far more important case, agricultural commodities, and see
the importance of distinguishing between prices expressed in dollars as
opposed to prices determined in U.S. dollars.
The Case of Agricultural Commodities:
Soybeans and wheat are two important, widely exported American
crops. In fact, American farmers suffer greatly when world prices of these
crops fall. The following graphs show that both crops experienced serious price
declines during the first decade of the current century. Some of this reflected
fluctuations in soybean and wheat production among countries.
But between half and nearly two-thirds of the declines and
subsequent increases in the prices of these two important crops can be
explained by movements in the price of the dollar. The dollar's price as
measured by its broad trade-weighted average exchange rate index[1] fell
from the 170-180 range at the peak of the dollar's overvaluation at the end of
the Tech Bubble to about 135 in the aftermath of the Crash of 2008. During this
period of falling dollar prices, the prices of both soybeans and wheat rose
sharply.
These two charts
dramatically demonstrate the importance to America's farmers of moving the
dollar back to a fully competitive exchange rate that balances imports and
exports. Because the dollar has gone up, the price of their crops has gone down.
When the dollar goes down to a more competitive exchange rate, the price of
their crops will go up![2]
Conclusion: Although contracts for America's
agricultural exports are written and settled in U.S. dollars, the exports
themselves must be priced at a level which makes them competitive with
exports of the same crops from other countries. Consequently, the higher the price
of the dollar, the lower the price that farmers receive.
Good crop prices require a competitive dollar, not the bloated, overpriced dollar that farmers have faced for most of the
past 40 years. No wonder the average American farmer is struggling so hard and
earning so little.
[1] Note that these figures
are an index number series indicating values of the dollar relative to
its average value against the currencies of other countries in 1990. These are
not exchange rates.
[2] In the two graphs, the right-hand axis showing the price indexes for
soybeans and wheat are inverted – higher prices appear towards the bottom and
lower prices towards the top of the vertical axis, thus making it easier to see
the significant inverse correlation
between the price of the dollar and the price at which U.S. farmers can sell
their crops at home and abroad.
America Needs a Competitive Dollar - Now!
