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Home Publications Blogs Beat the Press The Post Is Confused About Government Debt and Foreign Debt

The Post Is Confused About Government Debt and Foreign Debt

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Friday, 22 April 2011 05:02

Readers of the front page Washington Post article headlined, "the dollar, no longer almighty," no doubt walked away very confused. The article never distinguishes between the government deficit/debt and the trade deficit/foreign debt.

The dollar will likely fall because of the ongoing trade deficit. This is the adjustment mechanism for a trade deficit in the system of floating exchange rates like the one we have in the United States. This has no direct relationship to the budget deficit. If the United States were running its current deficit of around $600 billion a year (@ 4 percent of GDP), it would be expected that the dollar would fall regardless of whether or not the country is running a budget deficit.

The decline in the dollar will benefit workers who are subjected to international competition, most importantly manufacturing workers. The decline in the dollar will reduce U.S. imports by making them more expensive and increase exports by making them cheaper to foreigners. This will increase the demand for manufacturing workers, driving up their wages.

By contrast, workers who are largely protected by regulations against foreign competition, like doctors, lawyers, and other highly educated professionals, will likely lose when the dollar falls. They will have to pay more for manufactured goods and will probably not be able to raise their fees proportionately.

It would have also been useful to remind readers of the basic accounting identity that net foreign borrowing is equal to net national investment. An identity is something that is true by definition -- there is no possible way around it.

This identity means that if the United States has a large trade deficit, as it does now, then it must have either a large budget deficit or very low private savings, or some combination. (In principle, investment can rise, but as practical matter it is very hard to make non-residential investment rise by much as a share of GDP. Residential investment did rise substantially during the housing bubble, but it would be difficult to view this experience as health.)

This identity means that anyone who wants the budget deficit to fall without wanting the dollar to fall, want to see very low private sector savings. This would be a very perverse goal, although many policymakers seem to advocate this position without realizing it.

Comments (5)Add Comment
Inequality Identity Supersedes Accounting Identity
written by izzatzo, April 22, 2011 9:01
This identity means that anyone who wants the budget deficit to fall without wanting the dollar to fall, want to see very low private sector savings. This would be a very perverse goal, although many policymakers seem to advocate this position without realizing it.


Exactly. Since asset bubbles are a form of savings it's time to create another stimulus asset bubble like the last one to reduce the deficit and nominal private savings while pulling the economy out of jobless recession.

Under the Inequality Identity, income inequality must increase over each business cycle in order to keep the dollar strong.
...
written by skeptonomist, April 22, 2011 9:35
It is very strange that there is so much concern about the supposed fall of the dollar now, since most of its fall with respect to the 1973 level took place about 2002-2008:

http://research.stlouisfed.org/fred2/series/DTWEXM?cid=105

Since 2008 it hasn't really gone anywhere. The fact that its fall has been arrested certainly is not a reason to think that the value of the dollar is related to deficits.
Speaking of ...
written by OJC, April 22, 2011 8:24
... "the system of floating exchange rates like the one we have in the United States" whatever happened to the Article I Section 8 clause about how Congress shall have the power "To coin Money, regulate the Value thereof, and of foreign Coin, ..."?
Can't see US manufacturing returning
written by Steve, April 24, 2011 8:06
Even if the dollar declines enough to make prices of US goods more appealing, will the US be in a position to take advantage of it? Or will it just lead to more investment in Chinese goods?
equation?
written by Dave Kane, April 26, 2011 6:39
"net foreign borrowing is equal to net national investment. An identity... that is true by definition"

pardon my ignorance, but could you explain more about how they relate? maybe an equation that shows how they relate? Would help me understand...

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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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