The American Spectator

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If, by some strange coincidence, every foreigner who has a trade surplus with the U.S. decided to stop investing in the U.S., they would face a huge dilemma. They would still earn dollars by selling goods to U.S. consumers, but now they would be forced to buy goods and services from America. The trade deficit would disappear overnight. All of this talk about how our country is at the mercy of foreigners and that the dollar is falling because of the trade deficit is pure voodoo.

The real reason the dollar is falling is that the Federal Reserve is supplying more dollars to the world than the world demands. The value of the dollar is also falling versus gold, oil, and other key commodities. Consumer and producer price indices, even after removing oil and food, have accelerated. And they will continue to do so as long as the Fed holds short-term interest rates artificially low. The value of the dollar is a function of monetary policy, not trade deficits, statements by the treasury secretary, or foreign investment decisions.

Because China pegs its currency to the dollar, its inflation rate is also accelerating (its CPI is up 6 percent in the past year). If China were to continue to hold its currency peg, inflation would eventually erode its low-cost advantage. China should revalue its currency upward, but not to appease U.S. lobbyists. It should do so to stop importing inflation from the U.S.

TRADE AND BUDGET DEFICITS are not things that U.S. citizens should celebrate. But to panic about them is dangerous. Inflating the economy to reduce the value of the dollar, increasing taxes to slow consumption and reduce the deficit, or to become protectionist in order to stem the flow of imports are all damaging to the economy.

When the dollar declines, U.S. purchasing power on world markets is reduced and the American share of total world output falls. Tax hikes obviously reduce the incentives to invest and inflation undermines business decision-making. None of these policies are good for growth.

"Out of whack," or not, the trade deficit is a result of individual decisions. Attempting to fight it using ham-handed, mercantilist macroeconomic tools is wrong. If pessimists are intent on boosting saving in the U.S., the appropriate tool is to reduce tax penalties on savings. Whether or not this shrinks the trade deficit is anyone'-s guess.

topics:
Taxes, Trade, Business, Federal Budget, Oil