December 13, 2004

Looking at the trade balance data we find that, save for a brief period during the early 1990's, the U.S. trade balance has been in a deficit situation during the last 25 years. We have yet to experience the dire consequences predicted by the twin deficit mongers. While it is true that the U.S. dollar has experienced large and sustained appreciations during the January 1980 to February 1985 and the July 1995 to February 2002 time periods, equally interesting is the fact that the sustained appreciations were followed by periods of sustained decline. Moreover, the dollar decline was not even accompanied by any sustained increase in the underlying inflation or interest rates predicted by the twin deficit view. In fact, looking at the data on the foreign exchange value of the dollar, one is hard pressed to argue that the index is not mean-reverting. It returns to its Purchasing Power Parity level. The data is not favorable to the twin deficit negative view of the U.S. and the dollar.

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