Originally published in The Financial Times
October 15, 2007
A more competitive dollar is good for America
By MARTIN FELDSTEIN
The dollar has finally begun its long overdue correction. Its recent decline is just a prelude to the much more substantial
fall needed to shrink the US current account deficit, running at a nearly $800bn (£393bn) annual rate, about 6 per cent of
gross domestic product.
If the dollar remained at its current level, the US trade deficit would continue to expand because Americans respond to
rising incomes by increasing imports more rapidly than foreign buyers raise their imports from the US. Although a faster
growth rate in the rest of the world would raise US exports and reduce the US trade deficit, experience shows that even
substantially faster foreign growth would have only a very small impact. A lower dollar has to do most of the work of
reducing the global trade imbalance.
America's trade deficit must be financed by a capital inflow from the rest of the world. Since foreign investors are no
longer buying significant amounts of US stocks or direct investments in US businesses, the vast bulk of that capital inflow
must take the form of purchases of US bonds.
Even an unchanged trade deficit would require the rest of the world to buy $800bn of additional US debt over the next
year, an amount that would grow in future years because of the rising interest payments on our external debt.
The largest purchasers of this debt are foreign governments and their related investment funds. A big uncertainty hanging
over the dollar is how long those governments will be willing to keep adding to their dollar holdings, knowing that they
will eventually incur losses as the dollar falls. Even if governments are prepared to do so, private investors may drive the
dollar down as they try to shift from dollars to euros and other currencies.
Although any individual government or private investor can shift from dollar bonds to other currencies, they can do so
only if someone outside the U