Opinion Editorial | |
| Monday, September 20, 1999 | |
Current Account Deficit Unrelated To Budget Surplus |
Back during the Reagan years, liberals often whined that the budget deficit -- which was due solely to the 1981 tax cut, in their view -- was causing the U.S. to run a large current account trade deficit as well. This meant that the U.S. was becoming indebted to foreigners, which would ultimately reduce American living standards. Furthermore, large current account deficits were unsustainable, the liberals said, and would eventually cause the dollar to crash, leading to inflation, higher interest rates and, possibly, a recession. For these reasons it was important to reverse the Reagan tax cut and raise taxes for the good of the economy.
For a time, the data seemed to support the so-called Twin Deficits theory. From 1980 through 1989, the budget deficit and the current account deficit moved together. (The current account includes the trade balance for both goods and services plus remittances on U.S. investments abroad and foreign investments here.) However, in the 1990s, the relationship completely broke down. Today, the current account and the budget are moving in opposite directions (see figure). As the budget has moved out of deficit and into surplus, the trade deficit and the current account deficit have reached record levels. Last year, while the federal government ran a budget surplus of $73 billion, the trade deficit rose to $164 billion and the current account deficit reached $221 billion--both record levels.
Now, the same people who brought us the Twin Deficits theory in the 1980s are back. Today they are saying once again that the current account deficit is "unsustainable" and unless reversed will cause the dollar to plummet and reignite inflation. This, in turn, will force the Federal Reserve to further raise interest rates, which will slow the economy and trip-up the soaring stock market.
Since the budget is in surplus, these trade balance worry-warts can't use the old Twin Deficits theory any more to push for tax increases. So instead, they are arguing for further Fed tightening to forestall the inflation that the current account deficit supposedly is fostering. Also, they believe, higher interest rates will slow growth and reduce imports, which will help correct the current account imbalance.
The problem with this is that in the 1980s these same people made the opposite argument. Budget deficits caused the trade deficit, they said, because they raised interest rates, which raised the value of the dollar, which makes imports cheaper and exports more expensive. If that is true, then further Fed tightening will only make the current account deficit worse.
We can only hope the Fed isn't listening.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, September 20, 1999.
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