Two Generations of Trade Deficits: A Wee Complaint with Jared Bernstein

I was loving the latest from Jared Bernstein until I got to this passage:

I do know that we must start by lowering our economically large, persistent, and distortionary trade deficit, especially to the extent that it is pumped up by other countries manipulating savings and exchange rates.

Jared and I are the same age – both born in 1955. I started teaching economics when Ronald Reagan became President. It was about this period of time when we started witnessing persistent current account deficits. Most of us back then blamed a massive inward shift of the U.S. national savings schedule (created by Reagan’s tax cut for those of us who did not drink the Ricardian Equivalence Kool Aid) that led to a massive dollar appreciation. The next time we saw a large appreciation of the dollar was the late 1990’s. I recognize that Jared is channeling the excellent Dean Baker who often writes stuff like this:

Robert Rubin was also the chief architect of the “strong dollar” policy. Lloyd Bentsen, Rubin’s predecessor as treasury secretary, was quite happy to see the dollar fall. The logic was straightforward: A lower dollar would improve the US trade deficit. If the dollar falls relative to the euro, yen and other currencies, then it is more expensive for people in the United States to buy imported goods. Therefore, they buy domestically produced goods instead. Similarly, if the dollar falls in price relative to other currencies, then it is cheaper for people living in other countries to buy US exports. This will increase US exports, thereby further reducing the trade deficit. A lower valued dollar was in fact supposed to be one of the main dividends of the deficit reduction policy that President Clinton pursued from the start of his presidency. The argument was that lower deficits would lead to lower interest rates in the United States. If interest rates in the United States fell, then foreign investors would buy up fewer US government bonds and other financial assets. This gave us the lower dollar and improved trade deficit. That was more or less the picture until Rubin succeeded Bentsen as treasury secretary in 1995. Rubin began touting the strong dollar.

Dean is right to note the move to a mix of low interest rates and fiscal discipline that was part of the early Clinton years. This mix was the reverse of the Reagan macroeconomic mix. But as Dean blames the public statements of one official for the dollar appreciation over the next several years, I have a small problem:

If one thinks about the Clinton policy mix – fiscal restraint with easy monetary policy – it was the opposite of the Reagan policy mix. To the degree we lowered our interest rates relative to the rest of the world, one would expect ceteris paribus that the dollar would devalue increasing net exports. Of course the dollar appreciated and net exports fell but that was the result of the investment boom which led to a strong increase in real GDP, employment, and even real wages. When progressive critics complain that U.S. macroeconomic policy cost growth and jobs by letting net exports fall, they confuse cause and effect.

Should the U.S. pursue more national savings like we did in 1993? My answer would be no unless we could get more world investment given the legacy of the last several years with the Bernanke global savings glut combined with a dearth of investment. The hope in the U.S. is that we have our own infrastructure investment boom. Now if we can get nations like Germany and China to invest more, perhaps our next investment boom can be accompanied by rising U.S. net exports. But note alleged currency manipulation is not exactly the key issue.