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The Trade Deficit Leads to a Weaker Dollar, Not the Budget Deficit, Tell the Post
The Post flunks econ 101 yet again telling readers that the budget deficit threatens to lead to, among other things, a falling dollar. Of course, in econ 101 students learn that the bad story of a budget deficit is that it raises interest rates, which will raise the value of the dollar.
A trade deficit, by contrast, leads to an excess supply of dollars, which therefore causes the price of the dollar to fall. In places other than the Washington Post, the decline in the dollar is a good thing, leading to increased net exports and an improvement in the trade deficit.
--Dean Baker
COMMENTS (6)
Excellent points, and quite legitimate in normal times.
The budget deficit does result in more dollars being 'created' without regard to where they are held, which is the effect of the trade deficit/surplus.
Ordinarily the budget deficit would achieve a value equilibrium for the dollar with higher interest rates, again as you say.
However, in a period of quantitative easing, with the FEd also monetizing the long end of curve and quite a bit of other debt instruments like mortgages, the interest rate mechanism is short-circuited as it were, and the dollar tends to go down.
Interest rates are only a 'governor' and serve to modify the effects of budget deficits. Chronic deficits are able to overcome that mechanism with a loss of confidence, which is how serious inflations tend to gain momentum.
But all in all you are quite correct, and should be thanked for your reminder that the more foreign holders of your debt, the more likely you are to experience currency fluctuations, even if you are the mighty reserve currency.
Posted by: Jesse | November 4, 2009 11:38 AM
Until China decides to unpeg the Reminbi/Yuan from the dollar, I don't see the dollar crash that The Village seems be in constant fear of (10% unemployment as far as the eyes can see, that's not a big deal, but trips to Paris costing 50% more, that would be tragic). In fact, China's use of the peg to ride the dollar down and gain market share verus all the unpegged currencies is starting to cause the interventionist wails to rise to arrest the dollar decline, and a joint intervention, at least short term, will creat a squeeze on the dollar-carry trade and an (unfortunate) uptick in the dollar's value, which will make the trade deficit worse, but some how that deficit is one the WaPo never worries about.
Posted by: Rick Kane | November 4, 2009 12:46 PM
The Post loves to rail against the budget deficit, unless there's a Republican in the White House. If they gave their readers the accurate story about the trade deficits, the friends of the editors wouldn't invite them to dinner parties.
Posted by: zak822 | November 5, 2009 1:28 PM
The Post loves to rail against the budget deficit.
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