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 (6)

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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.


  6. Abai says:

    MMT Proselyte,Thirlwall’s law is valid for most ntinoas except the US and Japan. I am going to end this here if you see the posts in recent months, I have been insistent on many points. I have also been promising to not write on this anymore On the question of Iceland of course, as is always the case, one can make all kinds of arguments. Here is a fact a nation facing devaluation of its currency can only survive by making discretionary attempts to increase exports and come back to a trade surplus. The nation’s products may get the advantage of price competitiveness but non-price competitiveness is more important. Why would foreigners buy your product ?More importantly, I do not wish to be associated with analogies such as hyperinflation etc. What I am saying is that ntinoas want to be a creditor to the rest of the world rather than a debtor. If imports are high, they will definitely face currency pressures and the only way to come out of it is to target a trade surplus. No one has seen the future and ntinoas want as high a trade surplus as possible. Fact of life The US has had major issues with trade imbalances I find the solution of just relaxing fiscal policy alone without improving the trade performance silly. In fact, in the real world that is what is happening Geithner has been trying continuously to do something and Obama has promised to increase exports. Nations want to be net exporters and that is the reason one talks of currency wars etc. Of course, they shouldn’t be worrying about fiscal deficits but fiscal policy alone will not solve US’s problems. Now most economists mainstream or non-mainstream agree that imports reduce demand. In the US, the reduction of demand was not seen because of increase in demand created by private sector borrowing. When the private borrowing could not continue any longer, the effect of the trade deficit came back with a revenge. Now one can argue that the US could have relaxed the fiscal policy long back but that would have let the external deficits processes go on forever leading to both the public debt and the indebtedness to foreigners rising to unsustainable levels. The US should have targeted net exports long back by depreciating its currency and by support to the export industry. Coming back to my point you quoted. Here is from Marc Lavoie’s text Introduction To Post Keynesian Economics, Page 125Indeed, according to authors like McCombie and Thirlwall (1994), most governments impose severe constraints on growth as a response to external disequilibria arising from the overly rapid growth of imports. These countries have the means and the resources to grow rapidly, and they generate a domestic aggregate demand that is actually more than sufficient to justify a strong capital accumulation. Yet, these countries are constrained by a negative current account. It is true that a surplus in the capital account, arising from the influx of foreign capital, can easily compensate for the negative current account. But such a situation can only be a temporary one for countries other than the USA, since its currency serves as an international reserve asset. Indeed, countries cannot tolerate such current account deficits for too long because of the interest and dividends that must be paid on the accumulated external debt and foreign investments. In the long run, therefore, the current account must be balanced and imports must, at most, be equal to exports.The point is that when ntinoas run into current account deficits, they tighten fiscal policy to reduce demand and since imports depend on demand, it is hoped that imports are reduced. Exports on the other hand depends on demand in the foreign countries and won’t be affected much. Now whether you like it or not is a different matter, but thats the game. They also target exports but the first step is curbing demand. Now my comments are to highlight the fact that doing the opposite is a highly unsophisticated solution. The only way is for everyone to come together and decide how to trade with one another. Fiscal policy will then be the winner.