But what about confidence? I remember reading how Clinton at the beginning of his presidency was advised to raise taxes in order to lessen the fiscal deficit which would show the world that we took budget balancing seriously and as a result the dollar strengthened. Or do I have this wrong?

In short, if the next president wants to raise the value of the dollar, the last thing that he would want to do is to balance the budget.

Ummm... George Bush has done a great job of not balancing the budget, and that hasn't helped the dollar.

We have a couple of post hoc ergo propter hoc challenges to Dean's proper noting of what economics. Yes, ceteris paribus fiscal restraint leads to more national savings and a weaker dollar to encourage more net exports (call that reverse crowding out). During the Clinton years, we also had another event - a US investment boom.

Perhaps Ben was thinking along the lines of a smaller current account deficit taking pressure off the dollar? Or maybe he was thinking there would be less concern about debt monetization?

And I think he's old enough to remember the twin deficits.

I was at first thinking along the lines of MG's comment: given the "twin deficits" picture, we would associate a large budget deficit with a large current account deficit. A large current account deficit means that there are lots of dollars being sent abroad, the recipients of which would like to exchange them for their local currency, which would tend to depress the value of the dollar relative to that currency.

However, now that I think it a little further, the large budget deficit gives the recipients of dollars something else to do with them, namely invest them in US government debt. So even though the federal budget deficit may increase the current account deficit by increasing willingness of foreigners to accept dollars in exchange for their goods, the very fact that it does so means that the price of the dollar is being supported relative to the foreign currency...

"Next, what happens when we balance the budget. Well, in econ 101 land, we learn that there is less borrowing, which causes interest rates to fall. When interest rates fall in the United States, then fewer foreigners want to hold dollar denominated assets. (Why?, because they would be getting a lower rate of interest.) With foreigners buying fewer dollar denominated assets, the dollar falls in value." Dean Baker

I'm not an economist--I'm about to prove it--but I find Dean's explanation of why a balanced budget wouldn't strengthen the dollar out of whack with the real world. I can't see where the theory does much to explain the problem of a weak dollar causing higher oil prices.

Let me offer this explanation.

Our incessant borrowing has made the store of value that the dollar might have to risky to calculate. Traders don't feel that they can get a fair interest rate to cover the risk to stored value because China is distorting the market value of the dollar. The way for traders to cover the risk of getting stored value wrong is to inflate their prices.

If this is what is happening, then balancing our budget would bring down the price of oil as calculating the stored value of the dollar becomes less risky.

I'm speculating of course, but if economic theory is far out of whack with what is happening in the real world then in Hillary Clinton's words "Who cares what economist think."

wjd123,

if foreign investors (or any investors) were concerned that the government deficit/debt was so large that it couldn't be repaid, then this should be reflected in higher interest rates on U.S treasury bonds.

In fact, the nominal interest on 10-year treasuries is just 4.0 percent, lower than at at any point during the Clinton administration. (The real rate is even lower, since inflation is higher now.)

Obviously, investors have no concern that the U.S. government won't be able to pay its debt. Senator Clinton may want to join the creationists and flat-earthers, but I would not recommend joining her.

I agree with you Dean. I, too, don't know why the NYT gives valuable column inches to a crackpot like Ben Stein.

Ben Stein is a clown, I stopped reading him after the third nonsensical column. Then there's Mark Hulbert and his market horoscopes, amazingly always providing buy signals...

The NYT is absolutely going downhill, and business reporting is leading the way.

"if foreign investors (or any investors) were concerned that the government deficit/debt was so large that it couldn't be repaid, then this should be reflected in higher interest rates on U.S treasury bonds. "

The concern lies with U.S. real assets falling in value faster than tsy bonds are being eaten up be inflation.

Sure China etc. could transfer their savings out of dollars but this would adjust the exchange rate 'unfavorably'. Rather they wait for the rate of falling U.S asset prices to slow to less than real rate losses from inflation. At that point, interest rates will rise as additional 'savings' are shifted from tsy bonds to 'real' assets (stocks, real estate).

Taxes are a very powerful tool with many unintended consequences, despised by economists because they lie outside the monetary policy realm.

Taxing millionaires, especially oil millionaires, to fund a transition away from oil, would likely reduce inflation. The problem is most oil millionaires are very difficult to tax, even using inflation.

don't think what dean says paints the complete picture. Many are invested in treasury as they are betting on deflationary outcome in few years (like Shilling etc).
"Well, in econ 101 land, we learn that there is less borrowing, which causes interest rates to fall"

Or will higher interest CAUSE less borrowing??
and higher interest will support higher dollar.

if foreign investors (or any investors) were concerned that the government deficit/debt was so large that it couldn't be repaid, then this should be reflected in higher interest rates on U.S treasury bonds.

it doesn't take foreigners to know that we can't pay our debt. our own GAO has been saying this for years.

they've been buying our debt b/c we have the world's reserve currency, and the treasury market is one of the few markets for AAA securities that can absorb that amount of cash and liquidity. they don't have many other options.

The Fed increases the supply of money or in other words the supply of loanable funds and with an increase in supply the price (interest rate) goes down. But on the other hand too many dollars may be chasing the same amount of goods and inflation occurs and nominal interest rates go up. A paradox. Is it the supply/demand equilibrium that affects interest rates or expected inflation. Or does supply demand affect short term rates and expected inflation effects long term rates. Are long term rates the summation of short term rates, determine by supply and demand, or are they expected rates plus an inflation premium. I submit that once again the answer to an either/or question is both. Futhermore I submit there are numerous parameters that must be taken into account all at one time. And does interest rates versus the prospects of devaluation affect exchange rates. Again both. The discussion is not one or the other but both plus say the current account situation, the current debt situation both public and private at the given time under consideration, reserve currency positions,short run and long run prognostications. Feed all into a matrix of simultaneous equations, define the correlation coefficents and solve. Do the gestalt analysis. Looking at one variable and assuming all other things being equal is an arguement provides little edification and is easily countered and either side of the arguement can be wrong at the same time. Generating even a partial equilibrium not to mention a general equilibrium is a complicated undertaking; there are feedbacks moving both ways. Thinking about coherently is hard; explicating it in a coherent manner even harder but at the end of the day unless it is done we all just talking past each other.

Here's another paradox or really just a very hard task that must be accomplished in order to win the arguement and vanquish the careless that lead us to disaster. Take into account all the parameters and then compose a way to express it in a simple manner so it is understandable to most of us. To those who persevere in this endeavor and are successful will go great glory. Me, I keep working at it. Wish me luck.

"The Reagan deficits led to higher interest rates, which caused the dollar to rise and the trade deficit to soar"

The Bush/Cheney deficits led to lower interest rates, which caused the dollar to fall and the trade deficit to soar.

I'm beginning to think the economists are all full of crap about trade.

Bobby P - Probably for the same reason it gives prime space to Wee Billy Krystal, it's lost its way.

That's very good! I agree with you. I'm chinese, welcome to china.

Why do I not see an explanation of how to strengthen the dollar here?

How about the following possibility: A smaller fiscal deficit leads to reduced domestic income and reduced demand for imports. which leads to a drop in import prices (rise in the value of the dollar).

You might as well as why the NYT gives valuable space to idiots like Tom Friedman, David Brooks and Bill Kristol. That's the Times.

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