With the cover page of the Economist   worrying about currency wars, and various analysts arguing whether the US can or cannot win such a "war" (see Naked Capitalism for a discussion), I thought it would be useful to see where we now stand, in terms of "competitiveness", as understood by open economy macroeconomists.
Open economy macroeconomists typically defined competitiveness as the relative price of traded goods. Below, I've plotted the trade weighted value of the dollar against a broad basket of currencies in nominal (blue) and real (CPI deflated) terms (red), as measured by the Federal Reserve. Notice that by this definition, "up" is an appreciation.
Figure 1: Nominal trade weighted value of the US dollar against a broad basket of currencies (blue), and real, CPI-deflated (red). Blue square is for 10/15 observation. An appreciation is denoted by an upward movement. Source: Federal Reserve Board.What is interesting is that the dollar is weakening against other currencies, including the East Asian currencies. (For calculations regarding the Chinese yuan, see here.) Much of the depreciation has occurred as talk of QE2 has mounted.
The CPI-deflated value of the dollar has also depreciated. It's important to note that, as I discussed here [paper], the CPI might not be the most appropriate deflator, since it includes many nontradable goods and services; and in fact there is a theory which states that real exchange rates should appreciate over time as productivity rises relative to partner countries (see  ).
One might be more interested in the cost of produced goods, as opposed to price (see for instance this paper by Golub, as well as this paper). This suggests the use of unit labor cost deflated real exchange rates. In Figure 2, I plot the ULC deflated value of the dollar.
Figure 2: Log real (CPI-deflated) trade weighted value of the US dollar against a broad basket of currencies, from IMF (blue), log real, CPI-deflated from Federal Reserve (red), and log unit labor cost deflated from IMF (green). (1) the ULC deflated series pertains to industrial countries. (2) An appreciation is denoted by an upward movement. Source: Federal Reserve Board, IMF, International Financial Statistics.Note because it is difficult to obtain ULCs for many emerging market economies on a timely basis, the ULC-deflated index pertains to a narrow basket of currencies, excluding China. This limits the usefulness of the measure, but one can still see how US productivity and wage trends affect the index. Arguments that high labor costs have made US goods uncompetitive (at least relative to a couple years ago) seem unjustified. (One caveat: as pointed out in this post, divisia indices potentially miss out on big level effects....MORE