Twin Deficits and the Fate of the US Dollar: A Hard Landing Reexamined

Abstract

The tenuous macroeconomic climate that characterizes the U.S. economy today, signaled by record-level federal budget and trade deficits, has increasingly raised concern over the possibility of a hard landing for the U.S. dollar. This paper argues that such concern is warranted: a hard landing scenario – characterized by widespread capital flight and a large and sudden depreciation of the dollar – is indeed a realistic possibility. Further, the paper examines the tradeoffs of one strategy that has been offered to reduce the likelihood of a hard landing – confronting Chinese currency manipulation – and concludes that such a strategy involves potentially large tradeoffs, and is less preferable to one that falls more directly within U.S. government control, namely, reducing the budget deficit. Finally, it concludes with a brief discussion of the rationale for a strategy that focuses on reducing the budget deficit, and the prospect of fiscal discipline as a means to that end.