Working Paper: NBER ID: w1644
Authors: Paul Krugman
Abstract: This paper presents evidence strongly suggesting that the current strength of the dollar reflects myopic behavior by international investors; that is, that part of the dollar's strength can be viewed as a speculative bubble. At some point this bubble will burst, leading to a sharp fall in the dollar's value.The essential argument is that given the modest real interest differentials between the U.S. and its trading partners, the dollar'sstrength amounts to an implicit forecast on the part of the market that with high probability the dollar will remain very strong for an extended period. The paper shows that such sustained dollar strength would lead the U.S. to Latin American levels of debt relative to GNP, which is presumably not feasible. Allowing for the possibility that something will be done to bring the dollar down before this happens actually reinforces the argument that the current value of the dollar is unreasonable.
Keywords: strong dollar; exchange rates; speculative bubble; U.S. external debt; current account deficits
JEL Codes: F31; F32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| current strength of the dollar (F31) | implicit forecast by international investors that it will decline slowly (F37) |
| implicit forecast by international investors that it will decline slowly (F37) | significant U.S. current account deficits for over two decades (F32) |
| current strength of the dollar (F31) | U.S. external indebtedness levels (F34) |
| feasibility of projected levels of U.S. external debt (F34) | sustainability of the strong dollar (F31) |
| unfeasible projected levels of U.S. external debt (F34) | rapid decline in the dollar's value (F31) |
| market recognizing infeasibility (D52) | sharp decline in the dollar's value (F31) |