Spending, Deficit and the Dollar

Secretary Geithner now says that he sees signs of confidence and a strengthening of the dollar:

'U.S. Treasury Secretary Timothy Geithner said on Tuesday he saw signs of confidence returning to the U.S. financial sector and pledged that the United States would pursue policies that preserve the dollar's value. ... "We are seeing very active issuance in corporate bonds and equity markets and the banking system itself in the United States shows signs of more confidence," Geithner said. ... He said a $787 billion U.S. economic stimulus program, designed to boost demand over a two-year period, will have its largest impact on the spending side over the next six months. Geithner made no mention of calls from some U.S. lawmakers to consider another stimulus package, instead emphasizing the need for patience with the current one. ... That is "slower than typical for recoveries, but recovery nonetheless," Geithner said.'

He says this while many objective signs are heading in the other direction however. The US deficit topped $1 trillion this week, with every indication that it will continue to climb to levels never seen before either in terms of percent of economic spending or in terms of absolute value.

'The Treasury figures showed that the budget deficit so far in the financial year, which runs to 30 September, was $1.086 trillion - a widening of $94.316bn from the month before. And the situation has led to increasing anxiety among the foreign buyers of US debt, including China. It may force the Treasury to pay higher interest rates to those who buy its debt, to make it a more attractive long-term prospect, observers say. "These are mind boggling numbers," said Sung Won Sohn, an economist at the Smith School of Business at California State University. "Our foreign investors from China and elsewhere are starting to have concerns about not only the value of the dollar but how safe their investments will be in the long run."'

The Wall Street Journal discusses how deficits of these levels not only impact the strength of the dollar, but the spending plans and economic recovery.

'The U.S. Treasury Department on Monday said the government's annual deficit reached almost $1.1 trillion by the end of June, a once-unthinkable level that could threaten any nascent economic recovery by undermining the dollar and driving up interest rates. ... Surging deficits could also tie the administration's hands in responding to the economy's problems, by eroding support among voters and making Congress leery of adopting policies -- such as an overhaul of the health-care system -- that the administration believes are necessary for sustainable growth. It could be hard to win congressional approval for another round of fiscal stimulus, if that was seen as necessary, even as the economy continues to lag and the unemployment rate continues to rise, hitting 9.5% in June.'

However, getting the deficit under control is a matter of political will, and given the super-majority in the Senate, and total Democratic control of both the legislative branch and executive branch, the necessary push back will have to come from within. The Blue Dog Dems have already begun this process with their opposition to the health care proposals as they stand.

'But events are pushing Obama to a crucial decision: when and how to plunge more directly into the specifics of the sensitive negotiations. In particular, he is under mounting pressure to spell out where he stands on two of the most divisive questions confronting lawmakers: how to pay for an overhaul that will cost at least $1 trillion over the next 10 years, and whether it should include a new government-run insurance program as an alternative to private coverage.'

Of greater concern is the long-term impact on the strength of the dollar and the ability of the economy to recover within the next two year. The prior history of deficit-spending compared to strength of the dollar is not encouraging.