"Why did decades of “get tough” trade diplomacy with a vulnerable trading partner fail to shrink the deficit? The answer has to do with the fact that those trade measures did not address the underlying economic conditions that were contributing to higher levels of imports over exports. At issue was the fact that the record peacetime budget deficits during President Reagan’s first term were not matched by an increase in private savings or a drop in private-sector investment. By definition, a country will have a current account deficit if the sum of government budget deficits and private investment are greater than its private savings. When a nation saves less than it invests, the shortfall in savings must be supplied by foreigners who lend to that nation....
The contra argument.
“Well, given that it’s all about spending imbalances, exchange rate policy has nothing to do with it.” This is what John Williamson of the Institute for International Economics once dubbed the Doctrine of Immaculate Transfer. (Uh-oh, Erick Erickson’s gonna come after me …) It’s a popular fallacy, especially at the WSJ, although I’m not sure if it rises to zombie status.
