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When Barry Goldwater ran for president as a genuine conservative back in 1964 he was often labeled as an “extremist.” His campaign responded to this criticism with the slogan: “extremism in the pursuit of liberty is no vice.”
Goldwater’s descendants are swarming the political playing field these days in their efforts to attack Social Security and Medicare. They have no qualms about making assertions that are deceptive and inaccurate. And they are not above appeals to nationalistic/racist sentiments to advance their case. The slogan for the current crew could be “xenophobia in pursuit of Social Security cuts is no vice.”
This xenophobia comes out most directly in their stories that tie the budget deficit to borrowing from foreigners, with China always being mentioned as the big lender to raise fears. This presumably scores well in the fear factor with focus groups, but it has nothing to do with economic reality.
The tying of the budget deficit to US foreign borrowing, and specifically borrowing from China, turns economic logic on its head. The United States is borrowing from abroad because it has a trade deficit, or more precisely it has a trade deficit because it is borrowing from abroad.
The decision by foreigners, both private investors and central banks, to buy dollar assets such as government bonds, drives up the value of the dollar against foreign currencies. This makes imports cheap for people living in the United States and it makes our exports expensive to people living in other countries. This leads to the large US trade deficit as we import considerably more than we export.
The main factor driving this story is the desire of foreigners to hold dollar assets. In part this might due to the fact that they view the United States as a good place to invest. In part, the desire to hold dollars is driven by the view of the dollar as a safe haven – a currency that is expected to retain its value in a time of considerable uncertainty in much of the world.
To some extent, the decision to hold dollars is part of a deliberate effort to inflate the value of the dollar against other currencies. In the case of China and other countries that are relying on an export-led growth strategy, the decision to hold large amounts of dollars is an effort to keep their currencies from rising relative to the dollar so that their exports don’t become more costly to US consumers.
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It is very difficult to see how reducing the budget deficit affects these motives for holding dollars. In more normal times, a lower budget deficit could lead to lower interest rates, which would make dollar assets somewhat less attractive to foreigners. Although even here the story would be mixed since low interest rates could boost stock prices making investing in the US stock market more attractive to foreigners. However, in the current environment of near zero short-term rates and extraordinarily low long-term rates, it is not plausible that deficit reduction would lead to substantial further declines in interest rates.
A lower budget deficit presumably would not jeopardize the dollar’s status as a safe haven. So, it would not reduce foreign investors’ desire to hold dollars for this reason.
And there is no reason to believe that lower budget deficits would cause China and other countries to end their export-driven growth strategies. They would likely buy up just as many dollar assets if the budget was balanced as they are today.
At a given level of output, if the dollar holds its value, then the trade deficit will stay where it is, leading to the same flow of dollars out of the country. Of course, reducing the budget deficit can lower growth and in this way reduce imports and the US trade deficit. In other words, the only way that the deficit hawks can make good on the goal of reducing foreign borrowing is by slowing growth and raising the unemployment rate. Otherwise their deficit reduction agenda has nothing to do with borrowing from China or anyone else.
But the deficit hawks apparently don’t feel they can sell their case on the merits, so we get borrowing from China as a regular part of their story. That might seem pretty despicable, but cutting the country’s most important and popular social program isn’t easy. And this is Washington.
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