Martin Feldstein on the Current Account Deficit

Martin Feldstein asks Why is the Dollar So High:

The level of the dollar is part of a complex general equilibrium system. Nevertheless, it is helpful to recognize that the high level of the dollar is necessary to generate the current account deficit equal to the difference between national saving and investment. Understanding the high level of the dollar therefore requires understanding the reasons for the low level of national saving in the United States. Reducing the large current account deficit will require both a higher rate of national saving and a more competitive dollar. Although the necessary decline in the real value of the dollar can in theory occur without a decline in the dollar’s nominal value, the implied magnitude of the fall in the domestic price level is implausible. A decline of the real value of the dollar that is large enough to reduce the current account deficit significantly requires a significant decline in the nominal value of the dollar.

In case some are wondering – hasn’t the dollar recently devalued – our graph shows the nominal exchange rate since 2001 and indeed it has. Despite the fact that the dollar has devalued, we are still running massive current account deficits. But with the current mix of fiscal irresponsibility and tight monetary policy, Feldstein’s analysis strikes me as spot on. It is the low national savings rate that is preventing the real exchange rate from further devaluation. Congress can pass all the trade barriers against China that the politicians can muster up – until we increase our national savings rate, significant progress in reducing the trade imbalances will not occur. So my hope is that Congress stops playing the trade protection card and starts finding ways to reduce the fiscal fiasco created by the current Administration. A change in the macroeconomic mix towards fiscal restraint and easier monetary policy would tend to devalue the dollar even more, but that seems to be a better way to increase net exports than trade protection.