Friday, November 05, 2004

We're All Keynesians Now

The WaPo has an article about the sliding dollar. Here's the basics:

The dollar continued its decline in global currency markets yesterday, intensifying worries among some economists that mounting U.S. budget and trade deficits could send the U.S. currency into a tailspin.

But John B. Taylor, the Treasury undersecretary for international affairs, defended the Bush administration view that the deficits pose no danger of a dollar collapse. He issued a detailed rebuttal of what he called "scare stories."

The dollar fell yesterday to within a fraction of a cent of its all-time low against the euro of $1.2930 , trading as low as $1.2898 before rallying slightly to close at $1.2867. It fell modestly against the Japanese yen, and continued a sharp slide against the Canadian dollar, which rose to 83 U.S. cents yesterday for the first time in 12 years.

It was the second straight day that the dollar has fallen despite a surge in the stock market, continuing a trend that began in early October when it started slipping against the currencies of major U.S. trading partners. The declined rekindled the fears of some analysts that the dollar could be headed for a severe sell-off unless the White House and Congress make a major effort to shrink the budget gap.

"As the dust settles after the U.S. elections, the one theme that is developing is the growing recognition [in the markets] of the need for more dollar depreciation," economists at J.P. Morgan told clients yesterday, citing as one major reason the likelihood that "there will be no serious new policies to trim the U.S. budget deficit."

The dollar decline isn't necessarily "good" or "bad" in and of itself, unless you're a fan of European vacations. Lowers your purchasing power, but also raises demand for exports, assuming we still have anything left to export. It's more symptom than cause, really, and isn't necessarily something to be alarmed about, as long as it doesn't happen suddenly.

But, I was struck by this paragraph in the article:

Taylor said administration policies already in place will help shrink the trade deficit. One is President Bush's pledge to cut the budget deficit in half, as a percentage of the U.S. gross domestic product, by 2009. That would decrease the trade deficit because lower government spending or higher taxes would reduce the amount of money consumers spend on imported goods.

This is a fascinating passage. He's arguing deficit reduction plans will reduce aggregate demand, and therefore spending on imports, and that's a good thing. In other words, the president's policies are great because they'll reduce the trade deficit by making us all poorer?

This is a basic simple short run Keynesian argument - increase taxes/reduce spending and demand/output fall. But, it isn't the kind of argument Bush administration officials usually make (unless they're justifying tax cuts to increase employment after their other justifications disappear). It isn't the kind of argument sensible people really make over a 5 year time horizon. It isn't an argument that actually makes sense unless the guy is promising recession.


Though, this passage at the end is really the kicker:

President Bush's news conference yesterday did little to lessen concerns over the deficits, Wall Street analysts and currency traders said. Bush simultaneously promised not to raise taxes under the guise of tax simplification, to pursue a costly restructuring of Social Security and to cut the budget deficit in half by 2009.

The currency markets aren't buying it, said William G. Gale, an economist at the Brookings Institution.

And nor should we. report out soon.