Inflation Always Steals the Benefits of Devaluation

Though it's very incorrect, the prevailing view inside the political, media and economic establishment is that a weak dollar is helpful to commerce for it boosting the exporting capabilities of U.S. manufacturers. The latter assertion has sadly captivated politicians, reporters, economists and producers for centuries.

The problem is that the consensus view is completely false. For further evidence, we need only consider recent news accounts concerning commodity pricing pressures, which are nothing more than commodities rising amid the dollar's weakness.

As the Wall Street Journal reported last week, "The impact of escalating steel prices in the U.S. is starting to filter through supply chains." According to the Journal, steelmakers have increased prices six times since November, and the total increase has ranged from 20 to 30%.

As a result, Caterpillar, the world's largest construction and mining equipment manufacturer, is considering price hikes to offset the rising costs of production related to the steel-price increases. Whirlpool Corp. has announced price increases of 8 to 10% for its appliances.

None of this should surprise us. As is always the case, we trade products for products, and money merely facilitates the exchange. If it's devalued the price of production (from shipping costs, to inputs, to labor costs) must rise, and this must be passed onto the customer.

The truly dense in our midst, and this sadly includes most economists with the stature to comment on matters economic, believe that a falling dollar versus foreign currencies makes the goods we sell more attractive on the global markets. If only life were so simple.

Indeed, it once again needs to be stressed that if the dollar falls, input costs must rise. If the business is t-shirts, a sagging dollar may well make a $10 shirt more attractive both locally and internationally, but with cotton prices having risen 92% last year, the cost of making those t-shirts would have risen commensurately. Inflation always and everywhere steals the benefits of devaluation, thus eroding profits unless prices are increased.

Looked at historically, to read about the decline of the Big Three automakers, is to read about how their fortunes turned negative in the early 1970s. So true, but what fascinates this writer is that these accounts never tie President Nixon's severing of the dollar's link to gold to their misfortune.

The above omission is staggering for what it leaves out, not to mention the certain irony that it was the Big Three manufacturers themselves that sought a weak dollar on the assumption that it would make their cars more competitive versus those being produced in Japan. In this case pull with the government was a certain form of economic suicide.

Indeed, as Dartmouth Professor Douglas A. Irwin noted in his essential book, Free Trade Under Fire, for the typical American car, less than half of the inputs necessary to make the car are produced in the United States. In that case, a devalued dollar necessarily drives up the production costs for U.S. carmakers for the dollar buying less on global markets.

Of course this only tells half the story. If we consider the inputs purchased from U.S. producers, they of course transact in dollars too, and when the currency weakens, their costs must go up in concert with the devaluation. Money is veil, and changes in its value won't change the real price of anything. Devalue the dollar, and watch dollar costs rise.

So when we consider what happened to the Big Three in the early ‘70s, when Nixon let the dollar float, it predictably went into freefall and commodities such as steel spiked in dollar terms. In short, the dollar cost of production for U.S. carmakers rose, and worse, oil and its byproducts such as gasoline went skyward too.

This was particularly troublesome for U.S. carmakers best known for producing large, gas guzzling autos. The weak dollar and the resulting jump in gasoline prices made American cars unattractive both domestically and around the world, thus giving the Japanese automakers most notable for producing small, fuel efficient vehicles the economic opportunity of a lifetime. The rest is history.

Since 1971, the yen has risen over 200% versus the dollar, and contrary to alleged expert opinion which says that this would destroy the exporting capability of its manufacturers, global automakers such as Toyota and Honda have thrived. Despite the 1985 Plaza Accord which forced on Japan an even stronger yen against the dollar (up 109% from 1985 to 2007), the shares of Honda and Toyota respectively rose 676 and 833% over that timeframe.

Looking at the last period of major dollar strength from 1997 to 2000, far from hurting General Motors, its shares actually rose 56%. But as this column has noted too many times to count, the dollar's decade-long decline began a year later, and this shockingly didn't bother GM.

It did, however, speed its rush into bankruptcy. Whereas $10 oil in the strong dollar late ‘90s made large American cars attractive, the dollar's decline beginning in 2001 predictably led to oil and gasoline spikes on the way to $4/gallon gas.

Popular history will say that admittedly absurd contracts with their unions killed GM and Chrysler, but the more realistic truth is that expensive gasoline once again made what they were selling unappealing to strapped consumers. GM and Chrysler raced toward bankruptcy in 2008, and it was only a misbegotten bailout foisted on the backs of taxpayers that saved two companies that had very much earned their early deaths. The weak dollar's role here remains unsung.

So while we all as readers can expect mainstream commentary suggesting that cheap money is the cure for what ails us until our final days, empirical and anecdotal realities point to the exact opposite. The laws of economics haven't changed, and as such, you can't change the terms of trade by changing the units of account that various goods are priced in.

But well-connected manufacturers will continue to clamor for cheap money, and gullible politicians will grant their wishes. As for the rest of us, we'll have to suffer paychecks that shrink in value alongside reduced work opportunities until special interests and the politicians doing their bidding wake up.