- The Washington Times - Wednesday, June 13, 2007


In a recent, provocative National Bureau of Economic Research (NBER) working paper, Harvard economist Martin Feldstein, who served a stint as chairman of the Council of Economic Advisers during the Reagan administration and is now president of the NBER, asks, “Why is the dollar so high?” His answer is straightforward: “[T]he dollar must be this high to generate a trade deficit equal to the difference between national investment and national saving.” He explains: “If saving is low relative to the investment (in plant and equipment, inventories and housing), we must have a trade deficit to bring in the [financial] resources to fill the gap.” The flip side of a trade-induced current-account deficit is a financial-account surplus.

If America’s unsustainable economic imbalances (a very low national saving rate and an “unprecedented” trade deficit) are to be unwound in an orderly way without inflicting major damage upon the U.S. and global economies, Mr. Feldstein says that the value of the dollar will have to fall considerably.

Mr. Feldstein convincingly argues that “the low level of the U.S. saving rate [is] the primary cause of the high level of the dollar.” In addition to the unified federal budget deficit, which averaged 2.9 percent of gross domestic product (GDP) during the 2003-06 fiscal period, household saving has been plunging in recent years and is now negative. “It is the low and falling level of household saving that is keeping national saving so low and thereby causing the saving-investment gap, and, in turn, the need for a high dollar to generate an equivalent trade deficit” and its corresponding financial-account surplus, Mr. Feldstein argues.

In his paper, Mr. Feldstein specifically takes issue with those who argue that simply increasing U.S. saving will be an adequate policy prescription to reduce the trade deficit and wean America from its unhealthy dependency upon foreign saving to finance U.S. investment. He argues that an increase in domestic saving relative to U.S. investment is “a necessary condition for reducing the trade deficit, but it is not [a] sufficient” condition. A financial incentive is still required to induce foreigners and U.S. households and businesses to spend more on U.S. goods and services and less on the goods and services produced elsewhere in the world. That incentive is a broadly depreciating dollar, which makes American goods relatively cheaper than goods produced elsewhere.

In this paper, Mr. Feldstein does not specify how much the dollar must fall in order to reduce last year’s “unprecedented” trade deficit of 5.8 percent of GDP to a sustainable level. However, one fact is worth noting: As the dollar incurred a broad-based, inflation-adjusted) depreciation of 13 percent between 2001 and 2006, the U.S. trade deficit still increased from 3.6 percent of GDP to 5.8 percent.

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