By John R. Hansen, PhD, Founding Editor of Americans Backing a Competitive Dollar (ABCD)

Editor’s note: National Farmers Union recently endorsed the Competitive Dollar for Jobs and Prosperity Act (CDJPA), a bill that would work to realign the value of the dollar and make U.S. agricultural exports more competitive abroad. In this Q&A, John Hansens explains the mechanism behind currency realignment, why it is needed, its impact on key stakeholders, the costs and benefits, and possible synergies with other policy tools.

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 using current market exchange rates. If the dollar is overvalued, the price of U.S. products may well be too high to compete with similar products from other countries. For example, the “China Price” of the hammer in renminbi converted to dollars at the market exchange rate will determine the market-clearing price for the hammer expressed in dollars.

Discussion

A primary reasons that many Americans think the dollar does not need to be devalued is almost certainly the fact 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.

The Case of Hammers

For example, what is the “world price” of a hammer that you buy at the hardware store? A U.S. producer might be able to produce one for $20, while a producer in China might be able to 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 $20 hammer in the U.S. for $17 – the “China Price.” Thus we can say that, while hammers may sell in the U.S. and perhaps around the world for $17, making this the world price of a hammer, the price, though expres­sed in dollars, is actually determined in China – or more precisely, through global competition among all hammer producers including those from China.

Hammers are a trivial example because very few Americans today are employed making hammers. Let’s take a far more important case 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

Many people think that, because the world price of agricultural commodities is always given in dollars it should make no difference if the dollar itself is overvalued.

Soybeans and wheat are two very 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 in other countries. But between half and almost two-thirds of the declines and subsequent increases in the prices of this two important crops can be explained by movements in the price of the dollar.

As the dollar’s value, as measured by the dollar’s broad trade-weighted average exchange rate index for goods fell from the 170-180 range at the peak of dollar overvaluation at the end of the Tech Bubble at the turn of the century down to about 135 in the aftermath of the Crash of 2008, the prices of both soybeans and wheat rose sharply.

[Note that the right-hand axis showing the price index for soybeans and wheat in the two graphs are inverted, with higher prices towards the bottom and lower prices towards the top. This makes 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.]

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. When the dollar goes up, the price of their crops goes down. When the dollar goes down, the price of their crops goes up!

Although contracts for America’s agricultural exports are written and settled in U.S. dollars, the exports themselves have to be priced at a level which makes them competitive with exports of the same crops from other countries. Consequently, the higher the value of the dollar, the lower the price that farmers receive. And because U.S. consumers have the ability to purchase wheat and soybeans – not to mention all other agricultural and non-agricultural products that can be traded internationally, domestic prices tend to fall when international prices fall, and vice versa.

It makes no difference if an individual farmer exports or sells domestically. Good crop prices require a competitive dollar, not a bloated, overpriced dollar like those 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.

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