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Home Publications Blogs Beat the Press Paul Volcker Is Scared That the Trade Deficit Will Fall

Paul Volcker Is Scared That the Trade Deficit Will Fall

Wednesday, 28 April 2010 21:21

It's possible that he doesn't know this, but it is what he said. According to the NYT, Volcker said that: "He [Volcker] and other speakers expressed fear that without some action in the next year or two that reduces deficits for decades to come, interest rates could spike, the dollar could lose value or some other financial crisis would occur."

A drop in the dollar is the only plausible way to get our trade deficit closer to balance. A large trade deficit, by definition, means that the United States must have low national savings (barring an extraordinary and unprecedented uptick in investment). Low national saving means that we must either have large budget deficits or very low private savings, or some combination. So proponents of a high dollar (like Mr. Volcker) want a large budget deficit and/or very low private savings. It would have been helpful to point this fact out to readers.

Comments (4)Add Comment
written by izzatzo, April 29, 2010 7:17
This confusing issue seems to go something like this according to Baker:

With an artificial high dollar value, less real output is consumed than is produced by the US, because substantial aggregate demand "leaks" out in the form of excess import consumption and reduced domestic investment through a trade deficit.

To maintain full output and employment, the difference in demand is made up, either by more domestic consumption which results in lower private national savings, or more government spending which results in larger deficits.

In this tradeoff, the common mistake made is not to link potential inflation from excess government spending (or excess private spending for that matter), coupled with falling dollar value, back to the trade deficit, as a corrective offset of falling dollar value, which would capture the leaked aggregate demand and act to increase domestic consumption and investment, eventually increasing income and private national savings, while allowing for a reduced budget deficit at full employment.

The mistake gets more complicated in a deep recession when resources are not fully employed, where a tradeoff is assumed in the first place when none exists between the private and public sector, which cannot generally produce inflation within reasonable limits, even with government fiscal spending financed by borrowed printed money.

Yet for most, the same demand-pull inflation as if not in a recession, is still raised as a threat, but even if valid, would still feed back as a reduced dollar value to reduce the trade deficit and capture badly needed leaked aggregate demand to offset the recession.

But it's not generally interpreted that way. Instead, a falling dollar is constantly portrayed as an economic disaster waiting to happen, driven by budget deficit spending as if at full employment, rather than by reduced trade deficit spending which would act either to reduce budget deficit spending at full employment, or complement it with more aggregate demand in a recession.
written by AndyfromTucson, April 29, 2010 8:21
China's economy has been booming ever since they made it their policy to keep their currency weak. Meanwhile, the US has had a strong currency and our economy has been struggling. In these circumstances it is not clear to me why people like Paul Volcker worry about the dollar weakening.
written by skeptonomist, April 29, 2010 9:08
An increase in the price of imported goods would mean immediate electoral pain for the politicians who are considered responsible. By the time the boost in jobs kicks in, they could be out of office.

Volcker is an extreme inflation hawk who has to take most of the responsibility for the post-Depression unemployment high which still stands - maybe he's trying for a new record.
written by Glen, April 30, 2010 9:14
Michael Pettis has a very good posting about this subject......

China’s current account surplus must be equal to its capital account deficit. It doesn’t matter whether you think China’s trade surplus is caused by policies that force households to subsidize producers, or that place tariffs (hidden or explicit) on imports and subsidies on exports, or that force heavy currency intervention by the PBoC. In the end, these are all one and the same thing, and will have automatic balance of payments consequences. Krugman argues that since China restricts the capital account, the PBoC’s currency intervention automatically results in the Chinese capital account deficit and the current account surplus.

If this true, what are the consequences? Let us for simplicity call the rest of the world the US. If China runs a capital account deficit, the US must run a capital account surplus. That is, it must import savings from the rest of the world. This is one of the inviolable accounting identities.


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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.