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Return of the Twin Deficits: Consequences for the Dollar and the Economy

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Abstract

Does America’s return to “twin deficits” imply an unstable dollar or a return to the “declinism” of the 1980s? Ending the Cold War and establishing the Euro did leave the dollar in a fundamentally weaker position. The Clinton administration, however, eliminated the fiscal deficit. And although the large external deficit continued to increase, it was financed to a great extent by foreign direct investment that strengthened the real economy. Since the dot.com crash, however, the dollar has depended on more official and less stable forms of support – mostly portfolio investments from Japanese and Chinese central banks. In the longer term, given the difficulties of adjusting Western living standards to Asian competition, a global system of floating currency blocs seems probable. The U.S. is unlikely to maintain its dominant position by converting the “war on terror” into a geopolitical alliance comparable to the Cold War.

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2007-05

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Mario Einaudi Center for International Studies

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Twin Deficits; Declinism; Cold War; European Union; Clinton; Foreign Direct Investment; Japan; China; Asia; Central Banks

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