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Economic Reporting Review

October 4, 1999

By Dean Baker

Trade Deficit & the Dollar | Social Security & the Budget | Race & Housing | Europe | Russia | Outstanding Stories


"Ballooning Deficit Poses Risk to Economy"
John M. Berry
Washington Post, September 25, 1999, page E1

"Japan Gives Hint That It Will Act to Halt Yen's Rise"
David E. Sanger
New York Times, September 27, 1999, A1

Both of these articles discuss aspects of the U.S. trade deficit and its impact on the dollar. The Post article discusses the potential economic implications of the large trade deficit being run by the United States. While the article quotes several economists who point out that the deficit is not sustainable, it does not point out that the deficit was the predictable outcome of the high-dollar policy pursued by the Clinton administration. A highly valued dollar will cause a trade deficit because it reduces the price of imports, causing people in the United States to buy more foreign goods and services, while it increases the price of U.S. exports, leading foreigners to buy less from the United States.

As the article notes, a high dollar provides a short-term economic benefit in the form of cheaper imports, which have the effect of reducing inflation and raising living standards. However, a large trade deficit cannot be maintained indefinitely. At some point, the dollar must fall to the point where the deficit is brought down to a manageable level. The decline in the dollar will raise the price of imports and will increase inflationary pressures in the United States. In this sense, the high-dollar policy can be seen as policy that leads to short-term benefits, but which potentially has significant long-term costs.

At one point, the article quotes an economist who notes that both the over-valuation of the stock market and the dollar could be corrected quickly by plunges in the financial markets which would lead to a recession, adding, "we are sure no one wants to see the gap closed in such a disorderly fashion." Although the article presents no differing views, there are economic reasons why a rapid adjustment could be desirable.

By historic measures, the stock market is over-valued by between 50 to 75 percent relative to current and projected future profits. This means that people who buy stock at present are paying far too much for it. The over-valued stock market leads to an enormous generational transfer, since the people who are net sellers of stock are mostly older people facing retirement, while the biggest net buyers are workers in their prime earning years. Those who are concerned about generational equity should find the over-valuation of the stock market very alarming, since it is the equivalent of an enormous tax on younger workers.

This point can be illustrated with a simple example. Suppose that the stock market is over-valued by 50 percent. If a middle-income worker earning $40,000 a year puts $3,200 a year into a stock-based mutual fund, then the eventual correction would effectively tax this worker's savings at the rate of $1,600 per year. This is the equivalent of a 4.0 percentage point increase in the Social Security payroll tax. Anyone who was concerned about generational equity should find a transfer from young to old of this magnitude quite disturbing. For this reason someone might want to see the stock market correct very quickly.

It is also worth noting that articles in both the Post and Times have often presented the argument that nations should be willing to endure short-term pain in exchange for long-term benefits. For example, last December a Washington Post article asserted that many economists felt that Japan should deliberately induce an economic collapse: "The nation has two choices. The first, the course advocated by many international economists, is to close unneeded factories, allow inefficient companies to go bankrupt, deregulate the economy, and hope that out of the ashes of this collapse will spring new business." (See "Excess Capacity Slowing Japan's Recovery," by Sandra Sugawara, Washington Post, 12/25/98, page B9; ERR, 1/4/99.)

More recent articles have presented the argument for the merits of painful transitions in Germany (e.g. see "Another Crushing Defeat for Schroder in a State Vote," by Roger Cohen, New York Times, 9/20/99, page A8) and East Asia (e.g. see "Trying to Keep Recovery Going," by John Burgess, Washington Post, 9/23/99, page E14; "Asian Rebound Derails Reform as Many Suffer," by David E. Sanger and Mark Landler, New York Times, 7/12/99, page A1; and "Skepticism Over Korean Reform," by Stephanie Strom, New York Times, 7/30/99, page C1; see also ERR, 7/19/99, 8/2/99, 9/27/99.) Presumably the economists and policy analysts who believe that quick painful transitions are the most desirable route for these other nations would apply the same logic to the over-valuation of the stock market and the dollar.

The article concludes by wrongly asserting that the United States might be forced to raise interest rates to finance its current account deficit. A nation with a freely floating currency, like the United States, never has to raise interest rates to finance a current account deficit. If insufficient money is flowing into the United States to cover the deficit, then the value of the dollar will decline. The dollar will continue to fall until enough people are willing to hold it at the market price. At this level, whatever current account deficit still exists (the deficit will shrink as the dollar falls, because a lower dollar increases exports and reduces imports) will be fully financed by foreign investors. While the Federal Reserve Board may opt to raise interest rates to limit the fall of the dollar, this is a policy choice. The Federal Reserve Board will never be forced to raise interest rates simply to finance a current account deficit.

The Times article comments on efforts to weaken the yen relative to the dollar. The article discusses concerns that a rapid rise in the yen may reduce Japanese exports by raising their price. A reduction in exports could in turn put an end to Japan's recovery. The article, noting the large U.S. trade deficit with Japan, comments that "unless Japan recovers, the thinking goes, that deficit will not be reduced by much."

Actually, Japan's recovery is unlikely, on its own, to greatly affect the size of the trade deficit. Currently Japan is importing from the United States at a $54 billion annual rate. It is exporting to the U.S. at a $126 billion annual rate, yielding a $72 billion annual trade deficit. If its economy grew by 10 percent, and this led to a 20 percent increase in imports (both very generous assumptions), this would only increase Japan's imports to $65 billion, still leaving a $61 billion deficit.



"A Fiscal Deadline Could Force GOP to Break a Pledge"
Tim Weiner
New York Times, September 26, 1999, Section 1 page 1

"Noble Talk of Saving Social Security Is Muted by Political Gamesmanship"
Richard W. Stevenson
New York Times, September 29, 1999, page A20

"GOP Spending Bills Tap Social Security Surplus"
Eric Pianin and Juliet Epstein
Washington Post, September 30, 1999, page A1

"Republican Plan Would Delay Tax Credit for Working Families"
Tim Weiner
New York Times, September 30, 1999, page A1

These articles report on Republican efforts to pass appropriations bills for the next fiscal year, and the likelihood that they will not be able to avoid spending a portion of the surplus generated by the Social Security program. The article written by Stevenson correctly points out that the finances of the Social Security program will not be affected at all by whether the government spends a portion of the surplus it generates. The Social Security program will be issued exactly the same quantity of government bonds regardless of how, or whether, the federal government spends its surplus. This fact was also correctly pointed out in a recent Washington Post editorial ("False Debate," 9/23/99; A28). All the other articles use terms like "raid" or "siphoning" to refer to spending money from the Social Security surplus, leading readers with the impression that such spending will actually take money away from the Social Security program.

The Stevenson article describes the debate over restructuring Social Security as an effort "to insure the long-term viability of the system." Actually, the long-term viability of the system is already largely insured, and there is very little this Congress can do to affect it. According to the most recent Social Security trustees report, the system can pay all benefits through 2034 even if nothing is done. It can pay all scheduled benefits through its 75-year planning horizon with a tax increase that is less than 1.0 percent of GDP.

The article suggests that paying down the debt will help insure the long-term viability of the system by lowering interest rates and stimulating more investment. In reality, the economic impact of paying down the debt would be so small that they would barely affect the long-term projections. (See ERR, 9/27/99.)

It is worth noting that the first Times article characterizes the current budget debate as a battle over whether to use the projected surplus "to cut taxes, expand government programs, or pay down the federal debt." No one in the debate is proposing to expand government programs as a whole. President Clinton has proposed expanding certain areas of government spending, but under his budget proposal most areas of government spending, when adjusted for inflation, would decline over the next decade. The decline is even larger when measured relative to the size of the economy.



"Fannie Mae Eases Credit to Aid Mortgage Lending"
Steven A. Holmes
New York Times, September 30, 1999, page C2

This article reports on plans by the Fannie Mae Corporation, the nation's largest mortgage underwriter, to ease its credit standards. Since most banks will follow the standards set by Fannie Mae, this could significantly increase the availability of mortgages to moderate income families.

At one point the article discusses the growth of home ownership among minorities, commenting "home ownership has, in fact, exploded among minorities during the economic boom of the '90s." It then reports on a study which found that the number of mortgages extended to Hispanics, African-Americans and Asian-Americans rose by 87.2, 71.9 and 46.3 percent, respectively, between 1993 and 1998.

This comparison is extremely misleading. In 1993, the economy was just beginning to recover from the recession. Housing is extremely cyclical, so a comparison from a point near the trough of a recession and a business cycle peak will mostly just reflect the expected movement over a business cycle. It would have been more appropriate to compare the number of mortgages issued in 1998 with the number from 1989, the peak of the last business cycle.

To evaluate the growth of home ownership among minorities, it would have been most appropriate to examine the percentage of home owners in each demographic group. This has risen far by less than is implied in this article. For example, in the most recent data, the home ownership rate for African-Americans was 45.8 percent. While this is up from 42.0 percent in 1993, it is virtually the same as the 45.6 percent figure at the previous peak in 1983. (See "In Home Ownership Data, a Hidden Generation Gap," by Louis Uchitelle, New York Times, 9/26/99, Section 3 page 4.)



"In Europe's Economic Boom, Finding Work Is a Bust"
Anne Swardson
Washington Post, September 28, 1999, page A1

This article discusses the fact that recent economic growth in Europe appears to be creating very few jobs. The article presents an extremely confused analysis of this phenomenon. The fact that the same amount of economic growth leads to fewer jobs in Europe than in the U.S. logically implies that Europe has more rapid productivity growth. Economists generally view productivity growth as the primary measure of an economy's dynamism.

In fact, data from the Bureau of Labor Statistics (BLS) and the OECD show that most European nations have consistently enjoyed productivity growth of approximately 2.0 percent annually. By contrast, in the United States, productivity growth has averaged just over 1.1 percent for the last 25 years, although it has been somewhat higher since 1996. (The article cites a study showing that Toys R Us stores in France employ 30 percent fewer workers than comparably sized stores in the U.S., apparently failing to recognize that this implies that the workers in the French stores are 30 percent more productive.)

Almost without exception, economists view productivity growth as being good, since it is the main long-run determinant of living standards. According to data from the BLS, several European countries already enjoy levels of productivity that are comparable to the level in the United States. If these nations maintain an annual productivity growth rate that is near 2.0 percent, while the growth rate in United States remains on its 1.1 percent trend, by 2030 living standard across western Europe will be more than 30 percent higher than in the United States.

The fact that Europe's unemployment remains so high is attributable to the fact that its economy is not growing as fast as it could. Contrary to the assertion in the article's headline, there has been no European "boom," as growth there has averaged less than 2.0 percent over the last year. The most obvious explanation for the slow growth is the contractionary monetary policy being pursued by the European central bank. Even though Europe has an unemployment rate over 9 percent and almost no inflation, the European central bank is still keeping the real short term interest close to 2.0 percent. By contrast, Alan Greenspan allowed the real interest to fall to zero in the United States in 1992, as the economy was recovering from the last recession.



"Clinton Widens Plan for Poor Debtor Nations"
David E. Sanger
New York Times, September 30, 1999, A12

This article reports on an announcement by President Clinton that the United States would cancel the entire debt of poor nations that adhered to an I.M.F. structural adjustment program. At one point, the article presents the comments of Michel Camdessus, the director of the IMF, that Russia has had seven years of "real progress." The article does not point out that Russia's economy has actually contracted by nearly 50 percent over this seven-year period. Nor does it point out that its health care system has virtually collapsed, leading to a decline in life expectancy of more than six years. (See "A Letter From Russia," by Francis C. Norzon et al., Journal of the American Medical Association, 3/11/98, pp. 793-800.)



"In Home Ownership Data, a Hidden Generation Gap"
Louis Uchitelle
New York Times, September 26, 1999, Section 3 page 4

This article examines patterns of homeownerships among different demographic groups. It notes, that while homeownership rates for the population as a whole are at record level, this is primarily the result of an aging population. Within most demographic groups, the rate of homeownership is actually lower than its previous peak in 1982.

"Extensive Effort Seeks to Clarify Medicare Maze"
Robin Toner
New York Times, September 27, 1999, page A1

This article reports on the difficulty that the Health Care Financing Administration is encountering in trying to educate Medicare beneficiaries about the choices between alternative Medicare plans. The article points out that many it can be quite difficult to determine the exact nature of a plan's benefits and costs. People suffering from problems often associated with aging, such as poor eyesight or senility, may find it especially hard to make an informed choice among competing plans.

"Wary of the Internet? Just Try to Avoid It"
Gretchen Morgenson
New York Times, September 26, 1999, Section 3 page 1

This article reports on an analysis done by Prudential Securities, which found that most of the major market indexes contained a large percentage of Internet companies. For example, the analysis showed that 25.9 percent of the value of the S&P 500 is attributable to Internet companies. This means that individuals or institutions that view such indexes as safe investments are still very vulnerable to a collapse of Internet share prices.


Dean Baker is a senior research fellow at the Preamble Center and at the Century Foundation.

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