Source: AlterNet

Author: Paul Krugman

Emphasis Mine

Reality keeps intruding on the fevered Ayn Randian dreams of the Republican Party and other conservative critics of the Federal Reserve. Far from debasing the dollar, as the hysterics keep warning, the Fed’s moves to help the economy by easing money now appear to have resulted in a stronger dollar.

That’s great news, right?

Well, not exactly, according to Paul Krugman in Friday’s column:

Actually, the strong dollar is bad for America. In an immediate sense, it will weaken our long-delayed economic recovery by widening the trade deficit. In a deeper sense, the message from the dollar’s surge is that we’re less insulated than many thought from problems overseas. In particular, you should think of the strong dollar/weak euro combination as the way Europe exports its troubles to the rest of the world, America very much included.

Undeniably, the U.S. economy is seeing some growth lately, although there are also still signs of weakness. Employment may be rising fast, but wages are not. According to Krugman, America is offering historially low returns to investors with even long-term bonds paying only a bit more than 2 percent interest.

When it comes to currency markets, however, we are looking very strong in comparison to everyone else, especially Europe where the threat of deflation looms and many bonds are offering negative interest rates. Krugman:

This remarkable situation makes even those low, low U.S. returns look attractive by comparison. So capital is heading our way, driving the euro down and the dollar up.

Who wins from this market move? Europe: a weaker euro makes European industry more competitive against rivals, boosting both exports and firms that compete with imports, and the effect is to mitigate the euroslump. Who loses? We do, as our industry loses competitiveness, not just in European markets, but in countries where our exports compete with theirs. America has been experiencing a modest manufacturing revival in recent years, but that revival will be cut short if the dollar stays this high for long.

In effect, then, Europe is managing to export some of its stagnation to the rest of us. We’re not talking about a nefarious plot, about so-called currency wars; it’s just the way things work in a global economy with highly mobile capital and market-determined exchange rates. And the effects may be quite large. If markets believe that Europe’s weakness will last a long time, we would expect the euro to fall and the dollar to rise enough to eliminate much if not most of the difference in interest rates, which would mean severely crimping U.S. growth.

Krugman hates to be a Cassandra, but finds all of this especially worrying when you consider that our policy makers are not fully understanding the implications of the rising dollar. Even the Fed might be clueless. “Oh, and one more thing,” he adds. “A lot of businesses around the world have borrowed heavily in dollars, which means that a rising dollar may create a whole new set of debt crises. Just what the global economy needed.”

So Europe’s troubles, and the euro itself, is also our problem, even if it becomes a little cheaper for Americans to visit Europe for the moment. That’s the way it is in our interconnected world. But, Krugman warns the Fed:  “Don’t raise rates until you see the whites of inflation’s eyes!”

See: http://www.alternet.org/economy/paul-krugman-why-ayn-rands-economic-disciples-are-dead-wrong-about-dollar