Folks who took econ 101 know that currency fluctuations are the mechanism through which trade imbalances adjust. Countries with trade deficits expect to see their currencies fall in value. This makes imports more expensive thereby reducing the amount it imports. A lower valued currency makes its exports cheaper in other countries, thereby increasing its exports. With lower imports and higher exports, the size of the trade deficit is reduced. This logic is pretty basic and not really disputed among economists. That is why it is striking to see a Washington Post piece on the fall in the value of the dollar that never once mentions the trade deficit. In keeping with the Post's editorial policy, the article attributes the decline in the dollar to the fact that the U.S. has: "a rising budget deficit and few ways to bring it under control that investors see as viable." Of course, there is no direct relationship between concerns over the deficit and the value of the dollar, but if investors were really losing confidence in the U.S. government, as claimed in the article, then we should expect to see a sharp rise in long-term interest rates on U.S. government bonds. We don't. The interest rate on 10-year Treasury bonds is hovering near 3.5 percent, far lower than in the golden age of big budget surpluses. But hey, editorials aren't expected to include all the evidence on the other side. The article also presents another fallacious horror story: "The risk remains of a full-blown run on the dollar that could force the Federal Reserve to suddenly raise interest rates, dealing a potentially severe blow to the U.S. recovery. That could happen if major holders of dollars, such as China and Japan, begin to sell off their holdings." People who read the rest of the article know immediately why this story is absurd on its face. The rest of the article reports on how our trading partners are being hurt by the falling dollar. What would happen to Europe, Japan, and other countries if the dollar were to suddenly plunge by another 40 percent against their currencies? Their exports to the U.S. would collapse and their imports from the United States would soar, devastating their economies. Does anyone think these countries would allow this to happen? If the dollar started to plunge, it is the foreign central banks that would have to take the lead to stop the slide, not the Fed. Those of us who are concerned about the well-being of future generations are happy to see the dollar slide since this will reduce the trade deficit and therefore our level of indebtedness to other countries. The Post apparently is not in this group.
--Dean Baker
