Why does a weaker dollar result in lower domestic investment? and City Year Boston Investment Community Breakfast

Why does a weaker dollar result in lower domestic investment?

I am currently reading "Secrets of the Temple," about the Federal Reserve. On page 597-8 it quotes an economist who says "But a weaker dollar and smaller trade deficit would also mean less capital inflow from the rest of the world and therefore a lower level of domestic investment in plant and equipment and in housing." What I am not clear on is why a weaker dollar per se leads to "a lower level of domestic investment..." Could some explain this to me? Thank you in advance.


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Answer by simplicitus
It doesn't. And the economist is either wrong, or has been quoted out of context.

It is true that a smaller trade deficit does mean that the capital flow into a country goes down.
http://en.wikipedia.org/wiki/Balance_of_payments#Basic_analysis

But even incoming capital flow is "investment" in the financial sense, not "investment" in the economic sense.
http://en.wikipedia.org/wiki/Investment

and the shift says nothing about true domestic investment (i.e. the trade-off between consumption and investment)

There are situations where a weaker currency helps investment and case where it would hurt investment.

A weaker currency means that the country's exports are cheaper, so exports are likely to grow. That might mean that investments in the export industries would become more attractive and hence more common.

On the other side, a weaker currency might mean that people have less disposable income. A lower income says they can't buy as much so producers for the domestic market are not going to invest in producing more. (This is the situation in the U.S. today because of the recession; not because of the a weaker dollar)
http://krugman.blogs.nytimes.com/2010/07/07/why-isnt-investment-higher/

Which effect is more important depends on the reason for the dollar getting weaker; the state of the economy; etc. If the dollar got weaker because it is returning to normal after a world crisis that drove everyone to the dollar, then the weaker dollar is more likely to be good for investment. If the dollar got weaker because the economy is in the pits, ....

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Diane Exter - Event Chair, speaking at the Investment Community Breakfast.

December 7, 2012
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