Wednesday, 17 November 2004

Brad DeLong on the US dollar

Brad DeLong weighs in on the US dollar's decline.

[W]hen I repeated [Treasury deputy secretary John] Taylor's claim that the recent growth of the trade deficit was due to foreigners' eagerness to invest in the United States (rather than a decline in national savings) at the Berkeley Economics Department Tea, the reaction was general laughter--for Taylor's claim is false... [T]he Greenspan-Mann scenarios [of gradual decline in the US dollar] require (i) continued foreign central bank purchases of dollars on a huge scale as the dollar (gradually) declines, and (ii) that private foreign exchange traders continue to fail to make large bets that the dollar will decline. We need both of those to happen to repeat what took place between the Plaza and the Louvre Accords in the mid-1980s. If we don't have both of those over the next several years, the times will be very interesting indeed on the foreign exchange market...

Between 1995 and 2000 the trade deficit grew because investment rose as a share of GDP. Between 2000 and 2003 investment shrank, but the trade deficit did not fall. Instead, the trade deficit grew in spite of falling investment, in spite of rising private savings, because of the Bush budget deficit.

And true to what I discussed in my article yesterday, the fall in the US dollar is mirroring a parallel increase in the inflation rate. Yesterday, the Labor Department reported that producer prices rose 1.7 percent in October, the biggest gain in nearly 15 years. While energy prices was obviously a major factor, rising 6.8 percent, even core prices -- excluding food and energy -- was up 0.3 percent.

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