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19 January 2004


Import Prices Show Tiny Rise Despite Dollar Plunge

In one's first class on international finance, one receives an explanation of the effects of currency exchange-rate fluctuations on pricing. A strong currency means imports can rise, export become harder to sell abroad, and the economy usually enjoys a respite from inflationary pressures. A weak currency means imports fall, exporting is easy and inflation looms. December's import price data show why one needs to attend the second class.

Recently, the US dollar has dropped off the table, in large part due to the mismanagement of the US economy by the Bush administration and by the world military situation. It has hit all-time lows against the euro and multi-year lows against the yen. So, when the Labor Department issued December's import price figure of +0.2% last week, analysts were sent scurrying to explain why their estimate of +0.4 to +0.5% was off target.

The reason, in addition to the fact that Wall Street analysts are often wrong when it comes to guessing figures, stems from a political and historical fact that has little to do with economics. Because of the US predominance in the post-WWII capitalist west, the US dollar is the de facto global currency. It does have competition for the job from the yen and euro, but when gold or oil or wheat or fibre optic cable is traded, the price is usually in US dollars.

This has the effect of making much American trade with the outside world domestic trade. If non-Americans are prepared to accept US dollars as payment and can then spend those dollars without having to convert them into another currency, the foreign currency risk drops significantly. For example, a European oil company buys Kuwaiti crude in dollars, ships the oil to its refinery in Europe (transportation paid in dollars to a Liberian shipowner) and exports it to America where it sells the oil for dollars. This company has little need of euros except to pay its workers in its refinery. The effect is to diminish the impact of foreign currency fluctuations.

Where this will eventually break down is when non-Americans cannot swap dollars among themselves so readily. If the Kuwaitis suddenly want euros or Swiss francs instead of dollars, then the full impact of the foreign exchange-rate change will be felt. This means, of course, that one of America's national interests is in keeping up foreign demand for dollars. That can only be done by making sure and decline in the value of the buck is slow, steady and predictable. In other words, the current situation can't go on forever -- but it can last a lot longer than many think.

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