Why Deficits Matter: And Why the Coming Soft Dollar Policy Is No Solution to America's Huge Imbalances

By Chinn, Menzie; Steil, Benn | The International Economy, Summer 2006 | Go to article overview

Why Deficits Matter: And Why the Coming Soft Dollar Policy Is No Solution to America's Huge Imbalances


Chinn, Menzie, Steil, Benn, The International Economy


Chinese president Hu Jintao's recent visit to America provided ample grist for the media mills, but despite all the attention surrounding protocol gaffes the real story of the meetings was lack of progress along any policy front, including economic relations. In spite of Washington's chiding and threats over the growing trade imbalance, Beijing knows it has Treasury by the bonds. Roughly a third of China's central bank reserves, approaching an astounding $1 trillion, are in U.S. Treasury notes.

The question is therefore when the Administration and Congress will finally face up to the fact that America's deficits are American problems requiring American action. The current account deficit is now running at record heights of $805 billion, 6.4 percent of GDP, requiring about $2 billion of imported capital each day to sustain. Fueling the current account deficit is the Federal budget deficit, which, while down from 3.6 percent of GDP in 2004 to 2.6 percent in 2005 after a year of exceptional tax receipts, is set to soar anew on the backs of hurricane and war costs, runaway entitlement spending, and Washington's revealed preference for foreign borrowing over cutting pork and raising revenues at home. The recent $39 billion in projected spending cuts adopted by Congress for programs such as Medicare and student loans amounted to great dramatic theater, but a mere seven one-hundredths of 1 percent of GDP.

The Administration's response to the so-called "twin deficits" has been a yawn. In accordance with the vice president's neoeconomic postulate that "deficits don't matter," there is no policy beyond sending out the U.S. Treasury secretary at the bottom of a news cycle to cajole the Chinese into allowing greater currency "flexibility," which the whole world had feted them for not doing during the Asia crisis. These are therefore merely thinly veiled calls for a weaker dollar, no different from the devaluation cries heard routinely around the world from export interests.

But outsourcing deficit management to the currency market is junk economics and irresponsible geopolitics. Even if China revalues by the large levels demanded in such proposals as the Schumer-Graham bill, the yawning American trade gap will remain. Recent econometric analysis of the trade and currency data show the responsiveness of U.S. imports to movements in the dollar to be vastly lower than politicians assume. Thus, particularly because imports currently exceed exports by such a large amount, the higher dollar price of imported goods will make the trade deficit larger, at least until exports start growing rapidly. And that may take a very long while.

Furthermore, readjustments of relative prices via exchange rates won't bring much production back onshore. Textile factories that have closed over the past decade won't reopen even after a steep dollar decline. A significant Chinese revaluation will lead to higher imported sock prices at Wal-Mart, not a sprouting of new American sock plants.

America's comparative advantage vis-a-vis China is clearly in high-technology goods, particularly those with potential military applications. Yet these are precisely the goods the Administration is determined to keep out of Chinese hands, even in the face of European delight at the prospect of cashing in as Beijing continues its prodigious military build-up without American suppliers. It is difficult to envision, therefore, what precisely would stoke the sort of surge in U.S. exports to China that could make a serious dent in the ballooning trade gap.

The second flaw in a soft dollar policy is the naive belief that a dollar decline will be orderly and painless. This is what the Administration is banking on, but its own policies are guaranteed to undermine it. As U.S. policymakers continue to push forward with unbridled spending and tax cut plans that raise the trajectory of future budget deficits, foreign investors are certain at some point to turn their backs on the ever-expanding stock of U. …

The rest of this article is only available to active members of Questia

Sign up now for a free, 1-day trial and receive full access to:

  • Questia's entire collection
  • Automatic bibliography creation
  • More helpful research tools like notes, citations, and highlights
  • Ad-free environment

Already a member? Log in now.

Notes for this article

Add a new note
If you are trying to select text to create highlights or citations, remember that you must now click or tap on the first word, and then click or tap on the last word.
One moment ...
Default project is now your active project.
Project items

Items saved from this article

This article has been saved
Highlights (0)
Some of your highlights are legacy items.

Highlights saved before July 30, 2012 will not be displayed on their respective source pages.

You can easily re-create the highlights by opening the book page or article, selecting the text, and clicking “Highlight.”

Citations (0)
Some of your citations are legacy items.

Any citation created before July 30, 2012 will labeled as a “Cited page.” New citations will be saved as cited passages, pages or articles.

We also added the ability to view new citations from your projects or the book or article where you created them.

Notes (0)
Bookmarks (0)

You have no saved items from this article

Project items include:
  • Saved book/article
  • Highlights
  • Quotes/citations
  • Notes
  • Bookmarks
Notes
Cite this article

Cited article

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

(Einhorn, 1992, p. 25)

(Einhorn 25)

1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited article

Why Deficits Matter: And Why the Coming Soft Dollar Policy Is No Solution to America's Huge Imbalances
Settings

Settings

Typeface
Text size Smaller Larger Reset View mode
Search within

Search within this article

Look up

Look up a word

  • Dictionary
  • Thesaurus
Please submit a word or phrase above.
Print this page

Print this page

Why can't I print more than one page at a time?

Full screen

matching results for page

Cited passage

Style
Citations are available only to our active members.
Sign up now to cite pages or passages in MLA, APA and Chicago citation styles.

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn, 1992, p. 25).

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences." (Einhorn 25)

"Portraying himself as an honest, ordinary person helped Lincoln identify with his audiences."1

1. Lois J. Einhorn, Abraham Lincoln, the Orator: Penetrating the Lincoln Legend (Westport, CT: Greenwood Press, 1992), 25, http://www.questia.com/read/27419298.

Cited passage

Welcome to the new Questia Reader

The Questia Reader has been updated to provide you with an even better online reading experience.  It is now 100% Responsive, which means you can read our books and articles on any sized device you wish.  All of your favorite tools like notes, highlights, and citations are still here, but the way you select text has been updated to be easier to use, especially on touchscreen devices.  Here's how:

1. Click or tap the first word you want to select.
2. Click or tap the last word you want to select.

OK, got it!

Thanks for trying Questia!

Please continue trying out our research tools, but please note, full functionality is available only to our active members.

Your work will be lost once you leave this Web page.

For full access in an ad-free environment, sign up now for a FREE, 1-day trial.

Already a member? Log in now.