More on the Dollar

Following on from my previous post, the dollar can be boosted in very indirect ways. Given the zero-sum relationship between the nets of domestic investment and domestic saving, government spending and taxes, and exports and imports, an imbalance in the first two categories will require a balancing change in the third category, which is the current account balance. While many factors influence that balance, the exchange value of the dollar is one of the principal ones.

Given the explosive growth in the budget deficit recently and prospectively, positive growth in domestic investment relative to domestic saving will require a larger current account deficit to attract a larger capital inflow. It seems counterintuitive, but this need for foreign saving to supplement domestic saving in financing domestic investment will put upward—yes upward—pressure on the dollar.

That probably wouldn’t be a good economic outcome since it perpetuates global imbalances, but it may satisfy those who want a stronger dollar above all else. And, it may be a better outcome than having investment fall to match a diminished flow of saving.

Comments (5)

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  1. Brian W. says:

    Call it naïvety, but I am wondering why the first priority wouldn’t be to get taxes and government spending under control. Seems like that would provide the needed balance among the three categories that affect the dollar’s strength.

    Thanks, Bob, as always for an informative post.

  2. EHROSEN says:

    I have enjoyed your blog and appreciate your sharing your valuable insights with us non-economists.
    The past two posts, today’s in particular, I do not understand fully. Specifically, can you explain as you would to a six year old please, “positive growth in domestic investment relative to domestic saving will require a larger current account deficit to attract a larger capital inflow”. Are you saying that because we need Chinese money to buy ?stuff/?stocks?other investments, their money will flow to us more thus strengthening the dollar?

  3. EHROSEN says:

    OOPS…. I meant to add this. Thank you again for sharing your thoughts and I very much enjoy reading and learning from your blog. It helps level the playing field for the little guy and we appreciate it.

  4. Bob McTeer says:

    Especially for Ehrosen:

    What I did really was not fair. I based my post on a set of identities that I was too lazy to explain. I had done so some time ago, but I shouldn’t expect anyone to remember it. Also, I was motivated in part by the nonintuitive result my logic led me to.

    Take my word that I & S, G & T, and X & M must add up to zero, that is the differences add up to zero. I, G, and X are all “injections” into the income stream while S, T, and M are all “leakages.” In equilibrium injections equal leakages. If we don’t want investment to shrink down to inadequate domestic saving, then either the budget deficit must shrink (maybe to surplus) and/or the trade balance must become worse (M grow more than X) to bring in foreign capital. The way things are going, the budget deficit is not likely to shrink; so that alternative is ruled out. So, all the adjustment must come from the other two. If we want I to remain greater than domestic saving, then all is left is a worsening of the trade balance. This is not a “good” outcome, but I think it’s a logical outcome. A better outcome is for the three components of domestic saving to grow: the govt run a surplus, personal and business saving rise. Then you would also be able to enjoy a better external balance. My logic doesn’t explain HOW the external balance worsens, but one possibility is that Kudlow passes a magic wand over the dollar and makes it King Dollar. The irony is that King Dollar (externally imposed) would help finance our investment by worsening our trade balance. Just playing with his head.

  5. Bob McTeer says:

    To Brian W.

    You are right. I agree with you.

    See response to Ehrosen.