In an article on the new economic and budget projections released yesterday, the WSJ warned that China and other international investors "are growing bolder about questioning whether they will keep buying U.S. government debt at today's voracious levels." The Chinese government keeps down the value of its currency against the dollar (an action often described as "manipulation" by politicians and in news stories) by buying U.S. government debt. If it stopped buying U.S. debt, then its currency would rise against the dollar, reducing the U.S. trade deficit with China. This is exactly what both the Bush and Obama administration publicly claim to support, so it is difficult to understand why the public should be worried about getting what we claim to want. The article also confuses the trade deficit and the budget deficit. Foreign capital is needed to finance the trade deficit. In the absence of an inflow of foreign capital, the dollar would fall, as noted above. This would make imports more expensive (just as a tariff would), and make our exports cheaper to foreigners. As a result, the trade deficit would fall. Foreign capital is not needed to finance the budget deficit. In a context where the economy is below full employment, as is projected to be the case for the next five years, the Federal Reserve Board can finance the budget deficit by directly buying debt, as it has been doing. It would have been helpful if the article pointed out this fact, since there have been huge efforts by Obama administration critics to spread misinformation on this topic.
--Dean Baker
