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Return of the Twin Deficits: Consequences for the Dollar and the Economy
David P. Calleo, Director of European Studies, Paul H. Nitze School of Advanced International Studies, John Hopkins University

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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