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A NATION APART

The rapidly declining US dollar and why Americans shouldn’t worry too much

The US dollar has been declining.

During 2017, the dollar fell by around 10% against the currencies of its trading partners. With president Trump’s trade policies tending towards less free trade and more outright tariffs, as well as rhetoric from key officials suggesting the desirability of a weaker dollar, will the US see higher prices for imported consumer goods and, therefore, higher inflation?

The good news is that the effect of a weaker exchange rate on inflation isn’t very big in the US, simply because more trade contracts are executed in US dollars than in any other currency. A 2015 study (pdf) notes that 93% of US imports are priced in dollars.

The study estimated that “a 10% depreciation of the dollar relative to its trading partners will raise cumulative CPI inflation two years out by 0.4–0.7 percentage points.” The study concluded that if the dollar depreciates, US exports get less expensive whereas if the currencies of other countries depreciate, the result is bigger mark ups, profits, and consumer inflation.

We calculated that this amount of inflation would be equivalent to around $165 per year for the average worker in California or New York, around 12% of their annual transport costs or 13% of utility costs*. This is a material amount but still, not as significant as the impact of a declining currency on countries where inflation is more sensitive to import prices. One recent example is the UK where something similar has happened since June 2016.

Markets essentially took the vote for Brexit to be the introduction of an immediate trade wall. After the Brexit vote, the pound sterling was devalued by 10%. Since then, the UK has experienced a significant rise in inflation, with one study (pdf) directly attributing a rise of 1.7 percentage points in inflation (to as high as 2.6% last year) to the referendum. This amounted to a cut of £448 ($636 at current exchange rates) in annual pay for the average British worker. Put another way, the Brexit vote has cost the average worker almost one week’s wages due to higher prices.

The dominance of the dollar in trade remains a huge advantage for the US consumer.

*We based our calculations on wage and cost of living data sourced from Missouri Economic Research and Information Center, ADP Federal and State tax calculators, Governing MagazineNumbeo, and Expatistan.

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