The Heritage Foundation

Executive Summary #1855 on Trade, Economic Freedom

May 31, 2005

May 31, 2005 | Executive Summary on Trade, Economic Freedom

Executive Summary: The Brutal Price of a Dollar

Conventional wisdom about international trade deficits, China, and the dollar is confused. Headlines bemoan "dollar jitters," pointing to the troubling 30 percent decline of the greenback against the euro in recent years. Yet conventional wisdom also seems to believe that China is manipulating its currency and should allow it to appreciate and further weaken the dollar. This kind of confusion is dangerous: It sup­ports the faction of trade isolationists in America while averting attention from America's real problem of runaway congressional spending.

The dollar's recent swings against the euro indicate neither a dangerous erosion of U.S. power nor an opportunity for industrial rebirth. By the same token, forcing China off its peg is no panacea. While the dollar is worth less against the euro than ever before, we should remember that the euro is an infant cur­rency that has been in circulation only since January 1, 2002. As for the U.S. current account deficit of roughly 6 percent of gross domestic product (GDP), it is worth remembering that many countries with trade surpluses are less productive and are growing more slowly than the United States.

The record-high $61 billion monthly trade defi­cit is a sign of strength, not weakness. It reflects a balance of heavy foreign investment in the high-tech, high-productivity American growth engine. As Treasury Secretary John Snow has pointed out, America is growing much faster than other advanced nations. Nations with trade surpluses like Japan and Germany are economically stagnant and actually suffer much worse budget shortfalls than the U.S. suffers.

None of the suggested links between the federal budget, trade deficit, and dollar exchange rate withstands scrutiny. The basic measures of eco­nomic vitality are GDP growth and employment, and America's continuing strength, according to these measures, is due largely to its superior insti­tutions and freer markets. But all observers agree that the U.S. Congress has a very real challenge with fiscal spending, and global investors are bound to lose confidence in the mighty American growth engine unless the problem is fixed.

If Congress is dominated by weak leaders who cannot say no to spending, cannot acknowledge the entitlement crises, and cannot stop nudging up taxes, then investors are right to start questioning America's commitment to economic freedom. While big government is rhetorically out of fashion in America, actions speak louder than words. That concern hurts the dollar.

Tim Kane, Ph.D., is Bradley Research Fellow in Labor Policy in the Center for Data Analysis at The Heritage Foundation.

About the Author

Tim Kane, Ph.D. Visiting Fellow
Center for Trade and Economics (CTE)