Gambling on a Weaker Dollar

NYT Editorial

For some time now, shortsighted lawmakers in Congress have been threatening China with tariffs for what they call its unfair currency practices. The Bush administration, to its credit, has generally resisted the protectionist rant, most notably by refusing to brand China a "currency manipulator" in an official report to Congress last week.

China responded to the administration's responsible policy and diplomatic courtesy this week when it loosened, a bit, the tether that binds the Chinese currency, the yuan, to the dollar. A stronger yuan implies a weaker dollar, as does the general strengthening so far this year of the euro and the yen. By making foreign goods sold here more expensive and American goods sold abroad cheaper, a weaker dollar would, in theory, eventually help reduce the United States' huge trade gap.

The problem is this: unless a falling dollar is paired with reductions in the federal budget deficit, it could do more harm than good by driving up interest rates, perhaps sharply. That's because the foreign investors who finance the administration's "borrow as you go" budget are likely to demand higher returns to invest in a depreciating dollar.

But if budget deficits declined over the long run, the government's reduced need to borrow would help keep interest rates low as the dollar depreciated. Then, after a lag, the falling dollar would shrink the trade deficit without risking big increases in interest rates in the process.

Unfortunately, the incessant tax cutting of the past five years precludes any serious attempt to reduce the budget deficit. So to keep interest rates in check as the dollar falls, the administration would have to persuade investors not to believe what they see: a dollar that is declining even as the United States does nothing to curb its borrowing.

That would be a difficult trick even for a Treasury Department that commanded respect. It will be especially difficult for Mr. Bush's Treasury team, which has suffered a diminution of esteem and credibility.

The Bush tax cuts also make it harder for Americans as a nation to bail themselves out of the trade deficit by saving more. Higher personal savings would allow the government to finance its budget deficit without outsized foreign borrowing — another safe route to a cheaper dollar and a smaller trade gap. But the Republicans who control Congress let a tax credit for low-income savers expire this year to free up room in the budget for nearly $70 billion in additional tax cuts for high-income Americans over the near term.

That tax cut bill, signed into law this week by President Bush, also commits an estimated $53 billion through the middle of the century to help those same high earners shift their existing savings into tax shelters. This adds not one cent of new savings and presages big deficits far into the future.

A weakening dollar, on top of intractable budget deficits and a chronic savings shortfall, is a recipe for recession. The question now is whether the country will change direction in time. The portents are not good.