NCPA - National Center for Policy Analysis

Inflation Could be Around the Corner

December 8, 2003

The Bush Administration is looking for ways to reduce imports and raise exports. One way of doing this is to reduce the value of the dollar on foreign exchange markets. A lower dollar makes imports more expensive and exports cheaper in terms of foreign currencies. When this happens naturally, economists view it as part of the free market's automatic adjustment mechanism for trade imbalances, says Bruce Bartlett.

The problem is that this process is not taking place on its own, nor is it costless. The Treasury Department has been signaling for some time that it would not be displeased if the dollar fell. This sort of "benign neglect" can be as effective as direct action in foreign currency markets, such as having the Treasury sell dollars:

  • When currency traders know that we won't defend our currency, they take advantage of it by selling dollars against other currencies.
  • That is a key reason why the dollar has fallen sharply against the euro and is now at a record low.

Another effect of this weak dollar policy became evident in recent days when the OPEC oil cartel indicated that it might raise prices to compensate for the falling dollar, explains Bartlett. It has always priced oil in dollars, so a fall in the dollar means that its members have to pay more for goods and services purchased in Europe, Japan and elsewhere.

Although the signs are nascent, indications are that inflation is starting to show its ugly head again, the result of an extremely easy Fed policy over the last 3 years. Sensitive commodity prices like gold are up, the dollar is down and OPEC is again complaining about lost purchasing power, explains Bartlett.

Source: Bruce Bartlett, "Inflation Could Be Around the Corner," National Center for Policy Analysis, December 8, 2003.


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