The Other U.S. Deficit

WHEN PRESIDENT Bush batted away questions about the budget deficit during his news conference on Thursday, financial markets delivered a telling verdict. The stock market rallied, delighted by the prospect of continued low-tax policies, but the dollar fell to its lowest level in nine years. The next day's good news on job creation should have buoyed the dollar, but after a brief climb the currency headed down again. Economists have warned of a dollar collapse for several years now, and so far their alarmism has proved wrong. But some of them also warned of a stock market bubble in the 1990s, and after suffering some years of derision they were eventually proved right.

Even the possibility of a dollar crash should give Mr. Bush cause to rethink his tax policies -- if the prospect of burdening his children's generation with a massive national debt is not cause enough. Mr. Bush's budget deficit is so big that there aren't enough savings in the country to soak up the bonds he's issuing: The tax cuts are the prime reason for the expansion in the nation's overall savings deficit from 4 percent of gross domestic product in 2000 to almost 6 percent now. That gap has to be plugged by importing foreign capital, and if foreigners hesitate to provide it, the dollar falls until U.S. assets become cheap enough to lure them. This does not matter too much if the dollar's decline is gradual, as it has been so far. But the real worry is that investors may come to see a falling dollar as inevitable, precipitating a crash.

Mr. Bush may wish to ignore all this unpleasantness, but that may not be an option. Foreigners cannot be relied upon to inject upward of $500 billion into the economy annually forever; their reluctance may threaten not only a weaker dollar but scarcer capital, which will drive interest rates up.

This will be the markets' way of curing American profligacy: The weak dollar cuts American consumption and boosts production, leaving the nation with more savings to finance the budget deficit; high interest rates slow the economy and cut consumption further. The question is whether Mr. Bush allows these adjustments to occur at the whim of the markets, perhaps in a sudden and painful fashion, or whether he faces up to the nation's predicament and takes steps to smooth the transition.

The first step Mr. Bush should take is to present a serious plan to cut the budget deficit, not the phony five-year promise he touts now. Second, he should step up his quiet diplomacy to get China to revalue its currency against the dollar. Since the dollar peaked in February 2002, its orderly and welcome decline against the euro, the yen and other currencies has not cut the savings gap because China's currency has refused to budge, allowing Americans to carry on consuming cheap foreign imports. So long as China keeps its currency low, other Asian exporters that compete with the Chinese will follow that same policy. This inflexible Asian bloc accounts for fully half of America's trade deficit. Unless these countries allow their currencies to rise against the dollar along with the euro and others, the adjustment needed to head off a future economic gale is not going to happen.