A Weak $ Does Not Create Jobs

Unemployment hits 10.2%, the highest in more than 26 years.

Job losses are now approaching a two-year stretch of back-to-back quarterly losses.

So are government officials right to believe that a weak-dollar can stop rising unemployment?

This is an issue that is as vital as oxygen to the future of the US economy, to your jobs, and to your money.

The debate is picking up speed as the dollar continues to lose value in the $3.5 trillion currency market, and as central banks rotate away from the dollar towards euros and yen.

A growing phalanx of economists are saying that a weak dollar will help the US restructure its economy away from debt-ridden, cash-strapped US consumers, now 70% of US GDP, and towards exports.

“If we're going to go from a consumer-oriented economy to one that is more balanced, [the U.S. needs] a resurgence in its manufacturing sector," Robert W. Baird chief investment strategist Bruce Battles tells BusinessWeek. "The only way that can begin eventually is with a weaker dollar."

And Washington officials such as Federal Reserve chairman Ben Bernanke and Treasury Secretary Tim Geithner have made statements recently that emerging markets will help get the US out of its economic crisis.

In remarks about unemployment rising above 10%, a political and psychological benchmark, President Obama said the government would do more to help manufacturers export more goods, among other things (the last time unemployment soared above 10% in 1982, the Republicans lost 27 seats in the House).

A weaker dollar, the thinking in Washington goes, helps American exports by making them cheaper in foreign markets.

But are they right? Will that help the jobs market here in the US?

And are the experts right to think that American workers will eventually get cheap enough in foreign-currency terms that foreign companies will flock to our shores in droves and create jobs?

Will a weak dollar stop US companies from outsourcing to cheaper labor markets and keep jobs here?

Others point to the fact that foreign companies are setting up shop in the US to take advantage of the weaker dollar.

The Japanese car company Honda recently said it is shifting production to the US to capitalize on the strength of the yen (or weakness of the dollar). Toyota has had operations here in the US for years, as do many other foreign companies.

Or do other economists have it right by saying, not so, a weak dollar hurts US job growth, that, for one, a weak dollar is a tax on American manufacturers as it makes their costs rise as inflation takes hold?

They also point out that a weak dollar actually sends US companies, and jobs, flying overseas, as businesses take advantage of recycling foreign profits back in weaker US dollars, which makes the bottom line look a whole lot better.

So who is right in the weak dollar argument?

The answers are lot more nuanced than you may realize.

Dollar Pain

The dollar’s value pitched to 14-month lows in recent weeks, based on an index that measures the greenback's value against a basket of major currencies, including the euro and yen. It’s down 15% from the three-year high it hit in March.

In trade-weighted terms, the dollar is essentially back to where it was at the start of the financial crisis on August 9, 2007, according to Federal Reserve data. Currency traders expect it to drop further.

The reason is massive deficit spending and the Fed’s quantitative easing programs to defrost the markets ($6.8 trillion in gross exposures).

Also the Fed this week says US interest rates will remain close to zero for an extended period of time.

Growing Deficit

The US posted a $1.4 trillion deficit for the fiscal year that ended Sept. 30, or 9.9% of gross domestic product, the biggest since 1945 when World War II was ending.

The US is on course to post more than $9 trillion in cumulative deficits over the next ten years, hoping foreigners will continue to buy its debt even though it has no plans to balance its budgets for a decade.

With health reform and other expected stimulus spending, each year over the next ten years the US could easily be spending the equivalent of the GDP of Canada.

Also, interest costs on the debt are more than $190 billion, equal to the annual budgets of 15 US government agencies.

The federal debt to GDP ratio will rise from 41% of GDP in 2008 to 66% by 2012. It is on course to zoom toward 80%, perhaps 100% of GDP over the next 10 years—which means the US will soon join the ranks of Zimbabwe, Japan, Italy, Lebanon, even Jamaica when it comes to high government debt to GDP ratios, analysts note.

Meanwhile, tax and other revenues are at 15% of GDP, the lowest in the past five decades.

And Moody's Investors Service has told Reuters the US's triple-A rating is not guaranteed.

A Weak Dollar Destroys US Jobs

US companies are setting up shop overseas partly to be close to customers, partly because labor is cheap, partly because the US regulatory environment is hostile to manufacturers, and to take advantage of reporting foreign profits back in weaker US dollars, which makes the bottom line look a whole lot better.

The S&P 500 companies get about 40% of their revenues from abroad, Charles Schwab calculates.

Companies in technology, industrial, and cyclical businesses are most exposed to the trend, while health care and utilities stocks are more U.S.-focused.

Heavy-equipment maker Caterpillar (CAT) has seen its shares enjoy a sweet rise since the summer, as CEO Jim Owens tells BusinessWeek, "signs, particularly in China, that [government stimulus programs] are beginning to work."  

Similarly, Kraft Foods (KFT) CEO Irene Rosenfeld noted her company's overseas businesses while reporting recent quarterly earnings.

In North America and Europe, Kraft's "focus brands" are growing "in the mid-single-digits," BusinessWeek reports. But, she told analysts, "In developing markets, our focus brands continue to grow at strong double-digit rates.”

Likewise, Procter & Gamble spotlighted emerging markets in a recent quarterly earnings report.

"The opportunities here are boundless; 86% of the world's population is in emerging markets," chief executive Robert McDonald told analysts. "We will dramatically increase the percentage of total company sales from these markets," he added.

A Weak Dollar Causes Capital to Flee, Hurting Jobs

Economist David Malpass, a strong dollar advocate, says that a weak dollar uniformly causes capital to flow out of the country, in sums that overwhelm trade flows, causing more job losses than cheap real wages create.

The latest GDP numbers show that while US exports rose 14.7% in the third quarter, their best performance in two years, that gain was more than nixed by a 16.4% jump in imports, because consumers bought more from abroad.

Malpass notes that over the last century, this was the lesson of the British malaise, the Carter malaise, the Mexican malaise of the 1990s, and Yeltsin's Russian malaise.

The more the dollar devalued against the yen in the 1970s and '80s, the more Japan gained share in valued-added manufacturing, using the capital from weak-currency countries to increase productivity, Malpass says.

China is doing the same now, he adds.

And a weak dollar causes capital to flow to hard, unproductive assets that don’t create jobs.

“The real impact of a weak currency is that investors, knowing their returns will be eroded by inflation, seek out hard, unproductive assets (think housing, gold, art) least vulnerable to currency debasement, over investment in the productive, job-creating economy,” says John Tamny of RealClearMarkets.

Tamny continues: "A weak dollar is anti-investment as evidenced by stock returns in the ‘70s and this decade," and since jobs can't be created without solid capital, "to debase the dollar is to weaken the jobs outlook."

No Jobs Without US Consumers and Producers

And despite all the talk of a jobless recovery, the US cannot have an economic rebound without a working consumer, since consumers make up 70% of GDP, and consumers can’t buy unless producers produce. “There are no entrepreneurs without savings,” Tamny of RealClearMarkets says

He adds that the idea that a weak dollar helps make American exports cheaper is fundamentally flawed.

Tamny adds: "If we weaken the greenback in order to make foreign imports less attractive to US consumers, foreigners will lack the dollars to buy what we make. They forget that we’re the largest exporting country in the world, and if we’re debasing the currency, foreigners can buy less of what we produce."

"What these guys also miss is the longer-term impact of a weak currency,” adding, “Inflation IS a devalued currency."

Watch what happened in Iceland.

Iceland's krona has collapsed, forcing McDonald's to shut three of its chain restaurants there. McDonald's imports most of its raw ingredients, and when the krona fell through the floor, it became too costly for the restaurant chain to import items such as beef and cheese.

Fed Rate Hike Not Enough to Help the Dollar

Meanwhile, the Federal Reserve has no mandate to preserve the dollar’s value.

“The Treasury does,” says Tamny of RealClearMarkets, noting the US Constitution empowers Congress to coin money and regulate the value of the dollar.

But the dollar free floats in currency markets, and because there is no designated driver in Washington’s spending binge, the dollar has been on Mr. Toad’s wild ride.

Government “spending is the true tax,” Tamny says, adding, that “we could devalue our way out of…post World War II,” but back then “the dollar was fine,” due to the gold peg. “We simply need a dollar definition, preferably in terms of gold,” he says.

Moreover, the Fed raising rates is not the path to dollar strength. 

“The dollar was much stronger (gold at $400) when the Fed funds rate was at 1% in 2004,” Tamny notes adding the dollar then went into “freefall amid rate hikes.”

He adds: “The Fed issues dollars, but it’s up to the Treasury to communicate to the markets about the dollar’s value.”

Former Treasury Secretary Robert Rubin did this mostly well,” he adds, but his successors, Paul O’Neill, John Snow, Henry Paulson and now Timothy Geithner “didn’t and don’t want a strong dollar, and markets have complied.”

One Bright Spot

Currently 62% of the world’s reserves, the lowest on record, are in dollars and 25% in euros.

But the dollar won’t likely lose its status as a reserve currency. That’s because it’s unlikely global investors will flee to roubles or rupees or euros or yen anytime soon. Nor will you see trade executed in other currencies.

The big contender to the dollar is the euro, but the euro doesn’t have a deep, liquid sovereign debt market to back it up like the US has.

Plus countries in Europe are still saddled with high debts and they are running deficits, though not at the speed the US is.

And China can’t afford to have the dollar lose its reserve status, as it now has the largest lake of money in the world. that would cheapen its hoard of more than $2.27 trillion in reserves, $797 billion of which are US dollars, notes Fox Business senior editor Charles Brady (dollar reserves built up because of its huge trade surplus and because it buys dollars to keep its yuan pegged to the US currency).