Heritage Foundation Leadership for America

WASHINGTON, MAY 31, 2005—What threatens the U.S. dollar today? It’s not the Chinese government’s refusal to float its currency. Nor the record trade deficits the United States rings up each month. And certainly not the tax cuts President Bush pushed through in his first term.

No, the greatest threat is right here at home in the form of profligate, irresponsible, out-of-control federal spending. And as Tim Kane, a labor policy and economics expert explains in a new paper from The Heritage Foundation, profligate federal spending weakens not just the dollar but our economy as a whole.

“Congress is really confused on this issue. On the one hand, members think the dollar is too weak against the euro, and on the other they think it needs to be weaker against the yuan,” Kane says. “We should remember that investors globally put money into the American economy because it has proven to be secure and innovative and that we are in a constant battle to stay more productive, not more protectionist.”

Kane says the trade deficit, now running at more than 6 percent of GDP, signals strength in the economy, not weakness. The trade imbalance reflects “heavy foreign investment in the high-tech, high-productivity American growth engine,” he says. This explains why the United States continues to grow much faster than other advanced nations with trade surpluses, such as Japan and Germany.

As for the euro, Kane says, U.S. policymakers shouldn’t worry about the fluctuations of a currency that has been in existence for just six years. And they shouldn’t threaten China with a trade war over monetary policy, an attitude that reflects a dangerous isolationist spirit.

“America continues to fare well in the key measures of economic vitality—gross domestic product and employment,” Kane says. “And it continues to outshine other advanced countries because of its commitment to economic freedom.”

But part of economic freedom is restraining the government’s claim on the resources of its citizens, and that means restraining public spending. “If Congress is dominated by weak leaders who cannot say no to spending, cannot acknowledge the entitlement crisis and cannot stop nudging up taxes, then investors are right to start questioning America’s commitment to economic freedom,” Kane says. “While big government is rhetorically out of fashion in America, actions speak louder than words. And those actions are what is hurting the dollar.”