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Home Publications Blogs Beat the Press Morning Edition Tells Listeners That Large Budget Deficits Are Good

Morning Edition Tells Listeners That Large Budget Deficits Are Good

Friday, 12 August 2011 05:20

The folks at Morning Edition may not know that this is what they said, but in fact, this is exactly what a Planet Money segment on the dollar's status as a reserve currency implied. The segment told listeners that it was a good thing that foreigners demanded large amounts of dollars to use and hold as a reserve currency.

If foreigners increase their holdings of dollars then this means that the United States has a trade deficit. This is a logical implication of foreigners' efforts to acquire more dollars. In order to get more dollars, they have to sell more to the United States than they buy from the United States. There is no way around this.

If the United States has a trade deficit then it means that the country as a whole is a net borrower. That means that the combination of private and public savings must be negative. Again, this is an accounting identity, it must be true, just like 2+2 will always be equal to 4.

Generally private savings are roughly equal to private investment. The main exception is when asset bubbles like the stock market bubble or the housing bubble lead to a consumption boom and thereby depress private saving. (The housing bubble did also lead to a boom in construction, which as a component of investment allowed private investment to exceed savings, until the bubble burst.)

If the country has a trade deficit and private saving is equal to private investment, then the country must have a budget deficit. This means that in general circumstances, Morning Edition was telling us that budget deficits are good, since it told us that we should be happy that the dollar is the world's reserve currency.

There was another important aspect to this issue that the piece failed to mention. Even if the dollar is used as a reserve currency the amount that a country needs to support a given level of trade can vary enormously. The amount of reserves that developing countries hold soared in the wake of the East Asian financial crisis. This is usually attributed to the fact that the terms of the bailout imposed by the IMF on the countries of the region were viewed as being so harsh that developing countries wanted to make sure that they would never be put in the same situation. This meant accumulating massive amounts of reserves (i.e. U.S. dollars) as an insurance policy.

This was the origin of the massive trade deficits that the United States has been running in recent years. It would have been useful to make this point in this segment.

Comments (4)Add Comment
written by skeptonomist, August 12, 2011 9:48
To say that the 1997 Asian financial crisis was the origin of the trade imbalance is incorrect; the balance started going negative in 1991, and the trade-weighted dollar index was also increasing before the crisis:


But then the dollar index turned around in 2002, and since then the trade-weighted value of the dollar and and the trade deficit have been moving in parallel more often than not.

Certain principles may apply to international trade, but one thing is not going to explain it all. International economics is even more complex than domestic economics, and economists don't come close to explaining even the domestic case.
Say What?
written by izzatzo, August 12, 2011 9:50
Giddy gee whiz whadaya know Planet Money show with speed talker Jeeze the Jumping Jack to explain the ups and downs and ins and outs of what just happened:


Stupid liberals.
written by skeptonomist, August 12, 2011 10:02
I hadn't read down to Dean's earlier post about Robert Rubin when I wrote my last comment, though he has said the same thing before. While I also regard Rubin as a villain, the trade deficit can't really be pinned entirely on him either, for some of the same reasons. Note that the high value of the dollar vs the yuan was set at the beginning of 1994 when Lloyd Bentson was Treasury Secretary, though probably Rubin helped to keep it high. In 1994, it was probably regarded as a good thing to encourage trade with China to help convert it to a "free-market" economy.
Dollar and the Deficit
written by Dean, August 12, 2011 10:16

the value of the dollar would not explain everything. You would also have to look at the state of the domestic economy. The recession in 1990-91 gave us the small surplus of that period. But deficits were still modest until the big run-up in the dollar in 1997 following the East Asian financial crisis.
In terms of the relationship, the impacts will not be immediate, since quantities take time to adjust. The immediate effect of a lower dollar is to raise the trade deficit since we have to pay more for the goods we import. It is only after a lag that imports fall enough and exports increase enough to bring the deficit down.

There is also a problem with the real exchange rate series. We use the CPI as a deflator for the dollar. However, the price of health care and other services that are mostly not traded has been rising much faster than the price of goods that are traded. (This is not the case to the same extent with our trading partners.) This means that the index is effectively overstating the relevant inflation rate in the U.S. (the change in the price of traded items) and therefore overstating the decline in the real value of the dollar. The difference is on the order 1.0 pp a year, so it matters a great deal over 10-15 years.

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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.