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Home Publications Blogs Beat the Press Martin Feldstein Versus Accounting Identities

Martin Feldstein Versus Accounting Identities

Saturday, 02 March 2013 08:33

It is always painful to see an economist do battle with an accounting identity. Martin Feldstein takes on the task in a piece that explains that the dollar could fall sharply in the future, if investors come to expect its decline.

Most of what Feldstein says in this piece is exactly right. Investors do not need to hold dollars as a safe haven and in fact it is not a safe haven if it is falling in value against other currencies. Also, the vast majority of foreign dollar holdings are not necessary as foreign exchange reserves to finance trade. This means that we could in fact see large declines in the value of the dollar in the future.

The conflict with national income accounting comes in Feldstein's takeaway:

"And, despite a more competitive exchange rate, the US continues to run a large current-account deficit. If progress is not made in reducing the projected fiscal imbalances and limiting the growth of bank reserves, reduced demand for dollar assets could cause the dollar to fall more rapidly and the interest rate on dollar securities to rise."

Okay, if we reduce our fiscal imbalances and there is no decline in the dollar (remember, that is the bad news in this story) then what will happen to employment? Feldstein can't seriously believe that investment in equipment and software will increase substantially from what is already a reasonably high level measured as a share of GDP. He also can't expect that consumption will rise substantially given that the savings rate is already at a very low level compared to the post World War II average. And with enormous overbuilding in both the residential and non-residential sector, he can't think that construction will fill the gap in demand that will result from smaller deficits.

This would mean that the policy he is advocating is that we should deliberately slow growth and raise unemployment because if we don't the dollar will fall in the future. This would seem to contradict both common sense and what Feldstein himself has advocated in the past: allowing the dollar to fall to boost net exports.

Fans of accounting identities know that the only way that the United States will be able to have something resembling full employment without large budget deficits is with a sharp decline in the trade deficit. This in turn will only happen with a sharply lower dollar, precisely the event that Feldstein wants us to fear in this piece.

Of course the main obstacle to a sharply lower dollar now is the efforts by China and other countries to prop up the dollar against their own currencies to protect their export market in the United States. Perhaps these countries will all agree to raise the value of their currencies, as we have ostensibly been requesting, but that is not a change that is likely to occur anytime soon. If and when it does it would be good news for the U.S. economy, leading to a surge in manufacturing and employment, not the disaster Feldstein portrays.

It is always sad when economists take issue with accounting identities. It is even sadder that, in U.S. policy debates, they often win.

Comments (4)Add Comment
written by JSeydl, March 02, 2013 8:31
What's funny is that as long as China and other countries maintain the peg, it is an open invitation to run huge budget deficits. Without them, the only way the US can get close to full employment is through asset bubbles. The real question is whether we want huge budget deficits or huge asset bubbles. Recent history suggests that the latter is probably not the best way to go.
written by Chris Engel, March 02, 2013 10:22
So Feldstein wants us to fix "fiscal imbalance" (presumably to shrink the Public Deficit) to avoid a market devaluation of the dollar (an inevitability) when shrinking the fiscal deficit would only place the burden of the untouched Trade Deficit on the private sector to fund.

Very strange, and as you mention he has talked about the need for a weaker dollar to help private sector domestic production.

On this note, I'm curious what your opinion would be on overtly taking on policy positions that reject the dollar's world reserve status.

For example, why not actively DISCOURAGE the dollarization of internationally-traded financial assets (commodities especially)? This would maybe at least reduce the attractiveness of holding dollar cash-equivalents and maybe dent demand so we can start to more actively reduce the overvaluation.

Doesn't it make more sense to get out in front of this instead of letting the Chinese and others just continue to grow until there's a sharp change in response to probably yet another asset bubble in dollars? We're dangerously ill-equipped as I see it currently.
as solow pointed out the other day....
written by pete, March 02, 2013 4:47
Transfers are not a problem. Borrowing money to pay unemployment has little impact. As Solow stated, raising taxes to buy back bonds is another transfer, which has no real effect. Feldstein is wrong here, in that it is not the fiscal deficit that matters, it is the real spending on goods and services, mainly two new wars in Syria and North Africa, and out of control medicare costs. Hamilton calls medicare a transfer, I don't see that. It is spending on health care services.
Which is it?
written by LSTB, March 03, 2013 7:40
It's interesting that Feldstein thinks the current account deficit is a large problem when it's a much smaller fraction of GNP than the trade deficit is of GDP.

This would imply that only a small weakening of the dollar is necessary so all the Americans who own assets overseas get a better deal on their "exports." No need to fear a budget crisis/interest rate hikes/bond vigilantes/whatever.

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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.