January 25, 2015
The Washington Post had a major business section piece on the “winners and losers of a stronger dollar” which never explicitly discussed its impact on the trade deficit. This is truly remarkable since the $500 billion plus annual trade deficit (@3 percent of GDP) is the main cause of the economy’s weakness and continued high unemployment.
The logic of this is straightforward. The deficit is money that is income that is generated in the United States but is creating demand overseas. It has the same impact on the U.S. economy as if consumers decided to stuff $500 billion every year under their mattresses instead of spending it.
This is the main cause of the “secular stagnation” that has been widely discussed, even in the pages of the Washington Post. There is no easy mechanism for replacing this $500 billion in lost annual demand. We could do it with larger budget deficits, but deficit hawks like the folks at the Post, get hysterical at such suggestions.
In the last decade we replaced the demand lost from the trade deficit with the demand from a housing bubble, which generated record levels of construction spending (measured as a share of GDP) and an unprecedented consumption boom. In the late 1990s we filled the hole with the demand created by a stock bubble, which spurred investment and a slightly smaller consumption boom. However without another bubble, there is no plausible mechanism for filling this hole in demand.
The rising dollar will make things worse since the value of the dollar is the main determinant of the trade deficit. A rise in the dollar will make U.S. goods and services more expensive to foreigners, meaning they will buy less of our exports. It makes foreign goods and services cheaper for people living in the United States, causing us to buy more imports. The net effect will be a larger trade deficit and a loss of jobs.
The piece also makes a common mistake by implying that it matters that oil is generally priced in dollars:
“Oil prices are falling everywhere, but because the commodity is priced in dollars, American drivers are seeing a bigger discount than drivers in other countries.”
Actually, the story would be exactly the same if oil were priced in euros or yen and we saw a similar run-up in the dollar against the value of other currencies. The fact that the price of oil is generally quoted in dollars is of no consequence.
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