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Big Deficit Bob Rubin and the Strong Dollar

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Dean Baker
Truthout, September 8, 2009

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Robert Rubin’s reputation has taken a serious hit in the last couple of years. After getting glowing reviews for his stint as Treasury Secretary in the Clinton Administration, the world has now seen the fallout from the financial deregulation that he engineered and personally profited from to the tune of $110 million for his work at Citigroup. He now ranks only slightly ahead of Reverend Wright and Bill Ayers on the potential guest list at the White House.

In spite of his plunge, Robert Rubin is still over-rated. In addition to his other pearls of what passed for wisdom, Robert Rubin was also the chief architect of the “strong dollar” policy. Lloyd Bentsen, Rubin’s predecessor as Treasury secretary, was quite happy to see the dollar fall.

The logic was straightforward: a lower dollar would improve the U.S. trade deficit. If the dollar falls relative to the euro, yen, and other currencies, then it is more expensive for people in the United States to buy imported goods. Therefore they buy domestically produced goods instead.

Similarly, if the dollar falls in price relative to other currencies, then it is cheaper for people living in other countries to buy U.S. exports. This will increase U.S. exports, thereby further reducing the trade deficit.

A lower valued dollar was in fact supposed to be one of the main dividends of the deficit reduction policy that President Clinton pursued from the start of his presidency. The argument was that lower deficits would lead to lower interest rates in the United States. If interest rates in the United States fell, then foreign investors would buy up fewer U.S. government bonds and other financial assets. This gave us the lower dollar and improved trade deficit.

That was more or less the picture until Rubin succeeded Bentsen as Treasury Secretary in 1995. Rubin began touting the strong dollar. He was able to put some muscle behind this policy two years later as a result of the East Asian financial crisis. Rubin got the IMF to impose a policy on the countries of the region that essentially called for them to repay their debts by exporting like crazy to the United States. This meant taking advantage of currencies that were grossly under-valued relative to the dollar.

The financial crisis kicked off the era of exploding trade deficits. At its peak in 2006, the trade deficit was equal to 6.0 percent of GDP, approximately $900 billion in the current economy.

The big trade deficit was not the whole story. For those who know accounting, a large trade deficit implies a large budget deficit. In other words, even if they yelp endlessly about budget deficits being too high, proponents of a high dollar policy in fact support large budget deficits.

To see this, imagine an economy with full employment and no trade deficit. Now suppose that we just started buying 6 percent of our goods from abroad, instead of domestically produced goods. In this case, we would suddenly be in a situation in which the economy was well below full employment. Demand would have fallen by 6 percent, leaving roughly 9 million people out of work.

If the trade deficit remains in place, then there are two ways to replace the demand lost to imports. We can either have a big burst of spending from the private sector, which means less private sector savings, or we can have a big burst of spending from the public sector, which means less public sector savings.

In fact, we actually got some of both in the last decade. We did run fairly large budget deficits in the Bush years. However, a more important factor in boosting the economy was the extraordinary boost to consumption that resulted from the $8 trillion in artificial wealth generated by housing bubble. As a result of the bubble-driven consumption, which pushed the household saving rate to zero, the economy was able to maintain reasonably high levels of employment, in spite of a trade deficit equal to 6 percent of GDP.

Of course the bubble had to burst and the consumption driven by bubble wealth has also large disappeared. This means that if the economy is going to sustain high levels of employment in spite of a large trade deficit, then it will need to run very large budget deficits.

In short, because a high dollar leads to high trade deficits, it means that the country must run large budget deficits to sustain high levels of employment. In other words, a high dollar means a high budget deficit.

Does Robert Rubin know that his strong dollar policy directly contradicts his fixation with low budget deficits? Who knows and who cares? Either he is ignorant of the fundamentals of economics or he is dishonest. Either way, he is not the sort of person who should be taken seriously in economic policy debates. He belongs well below either Reverend Wright or Bill Ayers on the White House invitation list.   

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of Plunder and Blunder: The Rise and Fall of the Bubble Economy. He also has a blog on the American Prospect, "Beat the Press," where he discusses the media's coverage of economic issues.