Recent declines in the value of the dollar, while a welcome development, must be more broadly based among a larger cross-section of trading partners to bring the international accounts of the United States back into rough balance. Specifically, nations that actively manage the value of their currencies must allow the value of these currencies to rise vis-a-vis the dollar.
Today, the current us deficit is much larger than in the mid-1980s. Many of the United States trading partners have seen rapid increases in the sophistication and competitiveness of their economies over the intervening decade, meaning that a large dollar correction is warranted. A broad range of studies agree that the dollar still has a substantial adjustment to make. Forecasts from Obstfeld and Rogoff (2004) imply that adjustment will require a further 25% depreciation. Goldman Sachs has estimated that a 30% decline in the value of the dollar will be needed just to stabilize the NIIP at -55% of total GDP, while Mann (2004) argues that a 10% per year depreciation is needed just to keep the current account deficit stable over the foreseeable future.
Some economic observers may be surprised to hear the dollar's correction so far labeled as insufficient to restore external balance to the U.S. economy. Lately, the news has been dominated by the large dollar depreciation relative to the euro, with the dollar reaching historic lows in recent months. This dollar/euro correction has been dramatic, and it is a necessary and stabilizing first step toward unwinding the U.S. current account deficits. However, further drops in the dollar's value, while necessary, must be broader based, especially with regard to the bloc of nations whose domestic monetary authorities tightly manage the value of their currencies. For example, China, Malaysia, and Taiwan essentially enforce a hard peg of their currencies' values against the dollar, buying up dollars on global markets to keep the value of their own currencies from rising outside of a very narrow band. These nations need to allow more substantial dollar adjustment.
The current U.S. international debt path is damaging to future U.S. living standards. This damage has not materialized yet because interest rates have been at historic lows in recent years, making U.S. borrowing extraordinarily cheap. However, it would be irresponsible for economic policy makers in the United States to bank on these low rates. As soon as the interest rates begin to rise in the United States, the full consequences of the international current us deficit problem will have real bite.
The US trade deficit sector has a key role to play in bringing the U.S. economy closer to current us deficit. To boost net exports, the United States needs countries that peg the value of the currencies at low levels relative to the dollar to revalue their currencies. This does not imply that these nations should be encouraged to abandon capital controls and allow their currencies to ?float.? This would, in fact, be a bad idea. Rather, these countries should just allow their currencies to rise to a sustainable level against the dollar in a one-off revaluation.
Recent U.S. dollar depreciation against a select group of currencies, especially the euro, is a welcome first step toward returning the current account balance of the United States from current us deficit to a reasonable level. These currencies, however, cannot bear the entire burden of this adjustment.