When I was teaching economics in Texas, I was required to teach from a state-approved textbook. Like most economics textbooks, international economics was explained only in the last chapter. It is always short, with barely a mention of currency exchange rates. Invariably, time for currency exchange rates was rushed. Besides, that important subject would glaze the eyes of most people, especially students.
But such rates are important. They determine the cost of your exports and your imports, which directly impacts jobs. They also reflect your interest rates compared to other countries. Importantly, they reflect the international respect for your country and the willingness of other nations to do business with you.
For example, the nation of Turkey has been a long-running-train-wreck. It has an autocratic President, an 18% rate of inflation, and a history of currency collapses. Last Monday, the Turkish Lira dropped 7.5% in one day. The international community decided they didn’t want to own Lira unless absolutely necessary. Would you buy any Lira to hold as an investment? That collapse came the same day as their President Erdogan fired his third central banker in two years . . . for doing what central bankers must do to control inflation . . . they increased interest rates. Imagine our President firing Bernanke, Yellen, and Powell within two years.
Could the dollar collapse in such a dramatic fashion? Not anytime soon! That’s because the dollar is a reserve currency, defined as the currency specified in most treaties and business contracts. But, the dollar is not the only reserve currency. The Yen and the Euro are also reserve currencies. China has repeatedly declared its intention for the Yuan to become a reserve currency.
In the fairytale land of Modern Monetary Theory, deficits don’t matter, because nations with reserve currencies can simply issue more debt to pay off old debt. The old land of balanced budgets is immaterial. But, there is always a tipping point. You will know America is in trouble when our currency starts dropping dramatically. That is the “canary in a coal mine.” When foreigners sell their excess dollars, defined as dollars they don’t need for business, I will be selling stocks. In other words, when the dollar is no longer “investment grade” for foreigners, I will be selling stocks.
The opposition party, either Republican or Democratic, will always complain about our national debt. However, the opinion that really matters is . . . foreign opinion.