Th decline in the dollar has corresponded to further improvement in the trade balance with exports again surging in December. We have argued that the Bush administration and Fed is following a policy of benign neglect with respect to dollar in order to allow improvement in the manufacturing sector. Foreigners do not vote in US elections so if the value of their US assets decline, so what.
With the Fed lowering interest rates but credit tight in housing, the monetary policy impact will be felt in other market sectors. There is strong evidence that lowering rates does not help in a credit crunch if banks are unwilling to lend in a sector. The dollar decline or devaluation and the current account deficit story, however, is more complex.
A decline in the dollar does not mean that the terms of trade have changed. There are clear example of periods in trade history where there has been a change in the value of currencies but not the expected impact on trade. The US-Japan trade story is a perfect example. (Steve Hanke makes this point in a recent Forbes point of view column.)
More importantly, the current account deficit that is the worry of many is not solved solely by changes in exports. Imports are also important and the improvement in the trade balance has to do with the fact that the economy is slowing so imports are slowing. It may not show as clearly because of the high cost of energy imports but the improvement story has as much to do with a slowing economy in the US and stronger growth abroad as the decline in the dollar.
Do not forget that the dollar has been in a slight since 2001 over which time the deficit actually got bigger. There may be a tipping point for exports to increase but the driver is more likely decoupling of growth. The current account deficit also will not change by just changes in trade. The financial flows are larger and more important.
The current account deficit is also an accounting identity equal to the the sum of excess private investment over savings and the government deficit. The current account deficit will close when savings increase or the government deficits decrease. Since the government deficit is expected to grow, the closing of the current account deficit will have to be driven by higher private savings. The higher savings is most likely to come from a decrease in consumption relative to income. If consumers believe there has been a change in their wealth from say a decline in the value of their homes, there will be a retrenchment of spending. Consumption will decline and we will see an increase in savings. This is currently happening even with the strong retail number reported yesterday.
Trade balances will change but not because of a policy that allows the dollar to decline. The more likely channel of transmission will be through changes in growth and savings around the world which will change the aggregate demand for goods and services.
With the Fed lowering interest rates but credit tight in housing, the monetary policy impact will be felt in other market sectors. There is strong evidence that lowering rates does not help in a credit crunch if banks are unwilling to lend in a sector. The dollar decline or devaluation and the current account deficit story, however, is more complex.
A decline in the dollar does not mean that the terms of trade have changed. There are clear example of periods in trade history where there has been a change in the value of currencies but not the expected impact on trade. The US-Japan trade story is a perfect example. (Steve Hanke makes this point in a recent Forbes point of view column.)
More importantly, the current account deficit that is the worry of many is not solved solely by changes in exports. Imports are also important and the improvement in the trade balance has to do with the fact that the economy is slowing so imports are slowing. It may not show as clearly because of the high cost of energy imports but the improvement story has as much to do with a slowing economy in the US and stronger growth abroad as the decline in the dollar.
Do not forget that the dollar has been in a slight since 2001 over which time the deficit actually got bigger. There may be a tipping point for exports to increase but the driver is more likely decoupling of growth. The current account deficit also will not change by just changes in trade. The financial flows are larger and more important.
The current account deficit is also an accounting identity equal to the the sum of excess private investment over savings and the government deficit. The current account deficit will close when savings increase or the government deficits decrease. Since the government deficit is expected to grow, the closing of the current account deficit will have to be driven by higher private savings. The higher savings is most likely to come from a decrease in consumption relative to income. If consumers believe there has been a change in their wealth from say a decline in the value of their homes, there will be a retrenchment of spending. Consumption will decline and we will see an increase in savings. This is currently happening even with the strong retail number reported yesterday.
Trade balances will change but not because of a policy that allows the dollar to decline. The more likely channel of transmission will be through changes in growth and savings around the world which will change the aggregate demand for goods and services.
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