The dollar, which theoretically should have declined under the debt load in 2005, was buoyed last year by foreigners' willingness to park their cash in higher-yielding dollar-based assets while other developed economies sputtered. Investors were also drawn into dollars because of political setbacks in Europe, like the defeat of the European Constitution. And Congress helped to prop up the dollar by offering a one-time tax break that induced many American companies to convert their foreign earnings into hundreds of billions of dollars. But now Germany and Japan are rallying, the tax break has expired for most companies, and the dollar is facing new challenges: China, for instance, recently stated its intention to invest more of the dollars it earns in other currencies.
For the past few years, the United States' economy has overcome the drag of big deficits, mainly because the housing boom let Americans borrow and spend, despite stagnating wages. But the boom appears to be moderating, a slowdown that will only worsen if America's foreign indebtedness leads to sustained downward pressure on the dollar and upward pressure on interest rates.
Deeply in debt, individual Americans can't be expected to keep borrowing and spending. And government, also deeply in the red, won't be able to help much. Yet despite an estimated budget deficit of $400 billion this year, further tax cuts still top the Republican agenda.
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