September 13, 2013
Adam Davidson raised this possibility in his discussion of possible ramifications of the debt ceiling battle. He suggested that one possible outcome is that investors and foreign central banks cease to view the dollar as the world’s reserve currency. This would lead them to switch their dollar holdings to other currencies. The result would be a decline in the value of the dollar.
This is exactly what is needed to make U.S. goods more competitive in the world economy. If the dollar were to fall by 20 percent against the currencies of our trading partners it would have roughly the same effect on the trade deficit as if we would imposed a 20 percent tariff on imports and had a 20 percent subsidy on U.S. exports.
The trade deficit is now close to $500 billion a year or 3 percent of GDP. If we had balanced trade it would add roughly $750 billion a year to GDP (@ 4.6 percent of GDP), assuming a multiplier of 1.5 on traded items. This would lead to more than 7 million additional jobs bringing the economy close to full employment.
This sounds like very good news, especially since no economist has any good story as to how the U.S. economy can get back to full employment with a trade deficit of the size that we have seen over the last 15 years. We only managed to reach levels of output close to full employment during this period when the economy was being driven by bubbles (stock and housing).
If there is an alternative route to full employment, no one has bothered to write about it. From this perspective, a flight from the dollar as a result of a battle over the debt ceiling is probably the economy’s best hope for generating large numbers of jobs any time soon.
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