George Shultz and John Taylor take great comfort from the fact that the recent turmoil in the US housing market is contributing to a significant improvement in the US external current account deficit ("The silver lining in America's subprime cloud," November 6). However, by totally ignoring that turmoil's negative impact on capital account flows, they mistakenly conclude that it makes further depreciation of the US dollar less likely.

A principal reason that the unprecedented widening in the US current account deficit between 2000 and 2006 did not lead to a disorderly decline in the US dollar was that foreigners eagerly bought ever-increasing amounts of US paper, including subprime mortgages. Surely now that the housing bubble has burst, one must expect those capital flows to reverse as foreigners become increasingly wary of subprime paper and as the Federal Reserve is forced to reduce interest rates to support an ailing US economy, thereby eroding the dollar's interest rate advantage.

Given the very size of foreign dollar holdings, one must expect that the capital account effect of a further deepening of the US housing market slump will swamp any concurrent narrowing in the US current account deficit. This would be consistent with the marked pick-up in the dollar's pace of depreciation over the past month.

Desmond Lachman is a resident fellow at AEI.