No one expects sophisticated economic thinking from the Washington Post (a.k.a. Fox on 15th Street), but they really surprised readers with an article on the debt ceiling where they took the fall in the stock market as evidence that investors did not have confidence in the debt deal. After making assertions that investors believe the deal did not go far enough in cutting the deficit, the Post told readers:

"The lack of enthusiasm among investors for the deal was reflected in the U.S. markets. Stocks on Tuesday had their worst day in nearly a year, wiping out the gains made so far in 2011."

The most obvious explanation for the fall in the stock market would be a series of weak economic reports. If the issue is confidence in the ability of the U.S. government to pay its debt than the relevant market would be the bond market. Interest rates on U.S. debt fell on Tuesday hitting extraordinarily low levels, suggesting that investors have no concern whatsoever about the ability of the U.S. government to repay its debt.

The article also includes a very confused discussion about the status of the dollar as the world's reserve currency. It gets most of the basic wrong.

First it implies that it would be a bad thing for the United States if the dollar stopped being the world's leading reserve currency. It is difficult to see why this would be the case. The demand for dollars by foreign central banks pushes up the value of the dollar thereby making U.S. goods less competitive in world markets. The high dollar is the cause of the U.S. trade deficit.

A trade deficit also logically implies negative national saving. If we have a trade deficit of 5 percent of GDP (as we did before the collapse in 2008), then we must have negative net national savings. This logically implies (i.e. there is no damn way around it) that we will either have negative public savings (big budget deficits) or negative private savings (households spend their entire income).

For this reason, it is not clear why we would want foreign central banks to buy and hold large amounts of dollars. In fact, a newspaper like the Post, which has been crusading for deficit reduction forever, should be especially anxious to see foreign central banks reduce their holdings of dollars. (This is all the standard economics that business reporters should have learned in their intro econ classes.)

The article also implies that central banks have to hold dollars as reserves because there is no good alternative currency. Actually, the amount that central banks hold in reserves is not a fixed amount. The amount of money that central banks held as reserves soared in the years following the East Asian financial crisis in 1997.

The IMF treatment of the crisis countries was deemed so harsh by the countries in the region and elsewhere in the developing world that they began to accumulate massive amounts of reserves in order to avoid ever having to be in the same situation. Central banks don't need to find an alternative currency to park their reserves. They can just decide that they no longer need to hold so much money as reserves. If this happened, they could unload dollars. This would allow the dollar to fall and bring the trade deficit closer to balance.

 

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