Is the U.S. Purposely Devaluing the Dollar?

Former Fed Chairman Alan Greenspan apparentely thinks so as expressed in this November 11th, 2010 CNN Money article written by Aaron Smith.  On the other hand, Timothy Geithner disagrees, though there are many foreign leaders, such as Germany's Finance Minister Wolfgang Schäuble, who side with Greenspan.  Specifically, the accusations of the U.S. devaluing the dollar come from Bernanke's annnouncement of quantitative easing.  Essentially, they are printing more dollars in efforts to increase economic activity.  Its effect should cause the dollar to weaken make U.S. goods relatively cheaper to foreign goods.

In a complementary piece also on CNN Money, Greenspan elaborates on his charges.  He believes that the U.S. is reacting to China's slow pace in adjusting their currency in relation to the dollar.  While China has appreciated their yuan to a degree, many critics believe that it is still undervalued which gives them an advantage when selling their exports.  The flood of cheap Chinese goods to the U.S. market makes it hard for U.S. firms to compete, thus they end up either laying off workers in the U.S. or outsource jobs overseas where they will enjoy better cost advantages.  In order to counteract this, he believes the U.S. is engaging in currency manipulation in order to regain the advantage in world trade.  If the U.S. starts to boost exports through a cheaper dollar, then this can lead to more job creation here in the U.S.  That sounds good, but there's a downside to this strategy.

Other countries, particularly Europe, are complaining that the U.S. is being hypocritical and not following good policy.  Even though Geithner is urging other countries at the G-20 conference to not engage in currency manipulation, the Fed's latest actions appear to be counterintuitive to this concept.  While Europe has not resorted to devaluing the Euro through monetary easing, other countries like Japan and Brazil are following the U.S. in lowering their currencies to remain competitive.  The potential problem with constantly devaluing currencies is that it can lead to higher inflation and this scenario is consistent with monetary neutrality concept that we talk about in Principles of Macroeconomics and Mankiw's Money Growth and Inflation.  In particular, China's economy is at risk of overheating and resulting inflation could have a devastating impact on not only China, but the rest of the world.

Another troubling issue is that this could lead to a trade war as countries can counteract currency manipulations through protectionist practices.  Even if countries decide not to lower their currencies, they can always resort to restricting foreign goods through tariffs and import quotas.   The net effect of a trade war would be a rise in prices, job losses, and a declining economy.  Certainly, the U.S. is aware of that and do not want to create the perception of purposely devaluing currency.