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Home Publications Blogs Beat the Press Intro Econ for WAPO: Foreign Holdings of U.S. Debt Depend on the Trade Deficit, not the Budget Deficit

Intro Econ for WAPO: Foreign Holdings of U.S. Debt Depend on the Trade Deficit, not the Budget Deficit

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Wednesday, 20 July 2011 04:21

Many deficit hawks are anxious to exploit nationalistic sentiments and even resort to crude xenophobia to push their agenda of cutting Social Security and Medicare. The starring role in this story goes to the foreign holdings (especially Chinese) of U.S. government debt. The Post did its part by having a chart showing the growth of foreign holdings of "our mountain of debt."

Those who are actually concerned about foreign holdings of U.S. government debt should know that it depends on the trade deficit, not the budget deficit. The trade deficit provides foreigners with the dollars that they use to buy U.S. assets, including government debt. If the United States had large budget deficits, but balanced trade, then foreigners would only be able to buy more government bonds if they sold other U.S. assets, such as the stock and bonds of private companies. Conversely, if the country had a large trade deficit, but a balanced budget, then foreigners would be able to increase their holdings of government bonds by using the dollars they acquired to buy bonds previously issued, or newly issued bonds that replace expiring issues.

This is all simple econ 101. It means that the jingoistic budget hawks are yapping about the wrong deficit. The recipe for correcting the trade deficit (more econ 101) is lowering the value of the dollar against other currencies. This makes our exports cheaper for people living in other countries, causing them to buy more. It makes imports more expensive for people living in the United States, leading them to buy less.

Of course a lower dollar also has important distributional implications. It will have the effect of increasing the relative wages of workers in industries that are subjected to international competition, most importantly manufacturing. It will reduce the relative wages who are largely protected from international competition like doctors, lawyers, and congressional staffers. These distributional implications might explain why the media rarely discusses the over-valued dollar and its impact on the trade deficit and the economy.

Comments (5)Add Comment
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written by Ian, July 20, 2011 7:50
A weaker dollar would also mean higher oil prices, but even this has positive aspects as we will be able to invest more in alternative energy. Higher oil prices would in turn cause higher prices on most everything else, but it is a tradeoff for having a balanced trade deficit. Unemployment would likely drop under this scenario.
Both Manufacturing and Professional Services are Competitive
written by izzatzo, July 20, 2011 8:15
It will have the effect of increasing the relative wages of workers in industries that are subjected to international competition, most importantly manufacturing. It will reduce the relative wages who are largely protected from international competition like doctors, lawyers, and congressional staffers.


Rubbish. Any economist knows that relative wages of each moves in the same - not opposite - direction in response to changes in relative currency values.

If manufacturing wages increased due to more exports then professional wages obviously would increase as well as more professional services are exported in response to higher international demand at lower real prices.

Stupid liberals.
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written by Jay, July 20, 2011 9:44
The deficit hawks have persuaded people to believe that the budget deficit and debt is the result of us overspending on government. In order to finance government largesse we sold bonds to countries like China to meet our obligations. As a result, we are under the control of other countries because we spend more than we take it.

The above argument has to picked apart in plain language for ordinary people to understand and communicated often for ordinary people to comprehend what is going on. The Democrats has done a horrible job of attacking these arguments. The media has done a horrible job of presenting alternative views. Imagine if they took the time to address these views and explains how/why the US sells bonds to foreign countries. Instead media has one view and has continued to present it as the only legitimate explanation.

People do not understand that many countries have a lot of debt. They just know the US has a lot of debt. They don't understand why the debt is so high. Some people argue defense spending. Other argue entitlement programs. Then perhaps there is a faction that believes government employees compensation take all the money and the government wasteful spending on pork barrel projects.

It's pretty easy to predict views. Conservatives want to cut anything that helps the general public including taxes because it's a dog eat dog world. The liberals generally want to reduce national security spending, keep programs to help people, and increase taxes on the wealthy in order to do something about inequality and protect privacy.

It is not public knowledge that health care is a big component of our budget problem and it is hardly discussed relative to other perceived things that throw the budget out of whack. People do not understand monetary policy and trade. I studied some econ. However, we studied things like this late in the semester and scant attention was given to monetary policy.

It comes down to people seeking answers because they are not going to get them passively consuming the news or passively trusting conflicted economic advisors.
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written by skeptonomist, July 20, 2011 10:05
Reducing the value of the dollar should ultimately increase employment and wages in industries subject to international competition - and in general for that matter - but this will not come about until after the prices of foreign goods increase to the point that manufacturing in the US becomes competitive. WaPo editorialists and pundits in general are a couple of steps below understanding this, but I suspect that many politicians realize that if they took steps to reduce the value of the dollar they would be blamed for increasing prices at Walmart (and for German and Japanese luxury cars). This is a pretty simple connection to make for political propaganda purposes - lower dollar, higher prices. There is no gain without political pain when it comes to the value of the dollar.
You Left Out the Most Important Group Hurt by a Falling Dollar
written by Paul, July 20, 2011 10:47
The rich and the corporations they run! If the dollar bought less in Europe and Asia, the rich would not be able to enjoy their fabulous vacations to exotic places or to buy luxury yachts. Even the cost of French wine might be out of reach - that $350 bottle might jump to $500!

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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.

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