The High Dollar: President Clinton's Unaffordable Tax Cut
Everyone knows about George W. Bush's unaffordable tax cuts, the big tax breaks that gave millions to millionaires and billions to billionaires, but few people are aware of the even more unaffordable tax cut from the Clinton administration. That is because President Clinton's tax cut took a somewhat different form: an over-valued dollar.
While few people recognize it, the effect of an over-valued dollar on the US economy is very similar to the effect of large tax cuts. Tax cuts reduce revenue, which leads to deficits and a growing debt, which will impose a larger interest burden on the country in the future. In the same way, an over-valued dollar leads to a trade deficit, which results in borrowing from abroad. In future years, the country will have to pay interest on the money it borrows from abroad today, leading to lower living standards in the future. In fact, the most important difference between the two is that the trade deficit is much larger, clocking in at more than $800 billion in 2006 (6.1 percent of GDP), while the budget deficit is a comparatively modest $260 billion (2.0 percent of GDP).
Clinton did not start his administration with a high dollar policy. Lloyd Bentsen, his first Treasury Secretary, deliberately allowed the dollar to weaken in the first years of the Clinton administration, with the hope of keeping the trade deficit at a manageable level. When he left office in 1994, the trade deficit was less than 1.5 percent of GDP, a level that could be sustained indefinitely.
The high dollar policy came into being under Bentsen's replacement, Robert Rubin. Rubin argued that a high dollar would help control inflation. He made it the official policy of the Clinton administration to support a high dollar.
As a short-term measure, Rubin is exactly right; a high dollar does help to control inflation by making imports available at a lower cost. This has the effect of keeping prices lower in the United States and putting US manufacturing firms at an enormous competitive disadvantage. The basic story is relatively simple - if the dollar is over-valued by 20 percent, then this is equivalent to providing a 20 percent subsidy to imports, while placing a 20 percent tariff on all goods exported from the United States. With the high dollar policy in place, it should not be a surprise that we have lost more than 3 million manufacturing jobs in the last decade.
But, it is important to realize that the feel good part of the high dollar policy is only a short-term story. Just as a tax cut can put more money in people's pockets until the interest burden starts to exceed the size of the tax cut, eventually the foreign debt builds to the point where it is no longer possible to sustain the over-valued dollar. At some point in the future, the dollar will fall, and it will hit a level that is much lower than would have been the case if we had not built up a massive foreign debt (now more than $3 trillion) during the years of the high dollar. As a result future generations will be paying much more for everything that the country imports from abroad - oil, other raw materials, manufactured goods and services. In other words, future generations will experience lower standards of living because of today's high dollar, and the impact is more than three times as large as the impact of the budget deficit.
The blame for the high dollar policy is bi-partisan. It started under Clinton-Rubin, but it has continued in the Bush years, even as the trade deficit exploded to more than twice its previous record (measured relative to the size of the economy). The Bush administration could have taken steps to bring down the value of the dollar and thereby reduce the trade deficit, but this would have meant sharp increases in import prices, which would lower living standards. This would be no more popular than tax increases - it is not surprising that Bush would not choose to go this route.
Instead, President Bush continued the high dollar policy that he inherited from Clinton, obviously hoping that its collapse occurs when someone else is sitting in the White House. For the politicians, this is a convenient pass the buck story; only the person sitting there at the time will have to take the blame when the bill from the high dollar policy comes due. But, those of us who will have to pay this bill should be clear, it was Bill Clinton and Robert Rubin who started the tab running and George W. Bush who lacked the courage to close the account.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org).