The Dollar Carry Trade

Pleased by the prospect of the dollar declining? If foreign investors stop buying US bonds, that would be just great? The only mechanism for getting the trade deficit down is a lower dollar? It makes me sad to hear such views by prominent US economists.

Well, even Botswana can lower its deficit in this way. This is not an “accounting identity”, as Dean Baker called it. It is an accounting gimmick and a beggar-thy-neighbor policy. What if every nation was going to follow retaliatory competitive devaluations of their currency? According to the economics I know and have been teaching my students, this is a short-term “solution” which will backfire. Is it by accident that the world’s least competitive countries are the ones that are constantly devaluing their currencies? The trade deficit can only be reduced by increasing competitiveness and productivity, technological superiority, innovation, entrepreneurship etc. A constantly declining dollar will bring about inflation and higher interest rates for obvious reasons. US consumers’ purchasing power will drop. This will hurt manufacturing through a drop in consumption and demand for their products, and through an increase in their financing costs and imported raw material costs. They will become less competitive. This will increase the trade deficit. The decline of the dollar and its consequences will be exacerbated by the foreigners dumping the dollar and the dollar-denominated assets. I don’t know who will then finance the US debt. Americans will also try to protect their life’s dollar savings by converting them to stronger currencies, investing them in foreign-currency assets and perhaps moving them offshore. This capital exodus will further negatively impact the US current account deficit. Wall Street will plummet, and it will be very difficult for US companies to raise capital. A long-term Depression will hit the country. It’s a vicious circle. And gradually but surely the world will move to other reserve currencies. America’s economic and political standing in the world will erode.