Most people can relate to the realities of how jobs and profits shift, and why. The idea that higher-wage manufacturing jobs are being lost and replaced by lower-wage retail jobs, for example, is a reality that working people understand. They get it. The same is not always true when we talk about trade deficits. Like the falling dollar itself, it’s worth asking the question: How does it affect you, the individual?
The trade deficit—the excess of imports over exports—has a direct and serious effect on the value of U.S. dollars. As long as we continue having big trade deficits, it means we’re spending more money overseas than we’re making at home. Our manufacturing profits are lower than our consumption. If your family’s budget has a “trade deficit” of sorts, you’ll soon be in trouble. If your spouse spends $4,000 for every $2,000 you bring home, something eventually gives way. This is what is going on with the trade deficit.
In fact, the trade deficit is one of the most important trends in the economy, and the one most likely to affect the value of the dollar. Combined with our government’s big budget deficit, the trade deficit only accelerates the speed of decline in our dollar’s value. Speaking in terms of spending power of the dollar, the trade deficit is the third rail of the economy. Here is what has been going on: The United States used to produce goods and sell them not only here at home, but throughout the world. We led the way, but not anymore. The shift away from dominance in the production of things people need has allowed other countries (most notably, China and India) to pass us up, and now the U.S. consumer has become a buyer instead of a seller.
This international version of conspicuous consumption is financed not from the profits of commerce, but from debt. Let’s think about this for a minute. If we were buying from domestic profits, the trade deficit wouldn’t be such a bad thing. It would mean we were spending money earned from domestic productivity. But this is not what is going on. We are going further and further into debt to buy goods from other countries.
American wealth is being transferred overseas and, at the same time, Americans are sinking deeper into debt. This is taking place individually as well as nationally. Consumer debt (you know: credit cards, mortgages, lines of credit) is growing to record levels, and the federal current account deficit is moving our multi trillion-dollar national debt into new high territory.
Sure, we should be concerned about retirement income from savings, investments, pension plans, and Social Security. But a bigger danger is that, even with a comfortable retirement nest egg by today’s standards, what if those dollars are worthless when we retire? What then?
The big question today is, how long can this debt-driven economy continue? If you quit your job and refinance your home, you could live for a while on the money. The higher your equity, the longer you would be able to spend, spend, spend. But then what?
This is precisely what is going on in the U.S. economy and, at some point very soon, we are going to have to face up to it and change our ways. The trade deficit is the best way to track what’s going on. Returning to the analogy of quitting your job and living off of your home equity, you may stay home all day and order an endless array of electronics, furniture, toys, computers . . . in other words, you could consume goods in place of working. But remember, you didn’t win the lottery; you are financing this “new plan” with borrowed money. The lender will want that repaid. So this individual version of a trade deficit (the deficit between generating income and spending money) is what is happening on a national level in the United States.
This is the problem that is directly affecting the value of the dollar; and the situation is getting worse. We know that the dollar is in trouble because we see it depreciating against the floating currencies of other countries. America has a lot of wealth, but that wealth is being consumed very quickly. History shows that no matter how rich you are, you can lose that wealth if you’re not productive. Meanwhile, the dollar’s value falls and – in spite of the Fed’s view that this is a good thing – it means our savings are worth less. Your spending power falls when the dollar falls, and as this continues, the consequences will be sobering.
The dollar’s plunge has taken many people, currency experts of banks included, by surprise. For many of them, it is still impossible to grasp. Some talking head on CNBC said that he was at a complete loss to understand how such weak economies as those seen in the European Union could have a strong currency. For America’s policy makers and most economists, the huge trade deficit is no problem. They find it natural that fast-growing countries import money while slow-growing economies export money. At least, that is the recurring theme.
So Americans traveling abroad may continue to complain that “it has become so expensive to travel in Europe” as though the problem were somehow the fault of the Europeans. But in fact, it is the declining spending power of the dollar that is to blame, and not just the French, the Italians, and the residents of the so-called “chocolate making” countries.
This problem is pegged not to some speculative or fuzzy economic cause, even though the concept of currency exchange rates continues to mystify. A historically large trade deficit is at the core of the declining dollar. Somebody needs to get over the notion that our economy is strong and other economies are weak, merely because this is America. In the United States, the reason for the trade deficit is not a high rate of investment as we see in some other countries, but an abysmally low level of national savings. We are spending, not producing.
A second argument offered by some is that “capital flows from high-saving countries to low-saving countries, wanting to grow faster.” Under this reasoning, a deficit country, looking at both consumption and investment, is absorbing more than its own production. But whether this is good or bad for the economy depends on the source and use of foreign funds. Do those funds pay for the financing of consumption in excess of production (as in the United States) or for investment in excess of saving? That is the key question that ought to be asked in the first place about the huge U.S. capital imports.
To quote Joan Robinson, a well-known economist in the 1920–1930s close to John Maynard Keynes: “If the capital inflows merely permit an excess of consumption over production, the economy is on the road to ruin. If they permit an excess of investment over home saving, the result depends on the nature of the investment.”
The huge U.S. capital inflows (economic jargon for money coming into the country), accounting now for more than 5 percent of gross domestic product (GDP), have not financed productive investment. America’s net investments are among the lowest in the world, meaning we prefer spending and borrowing over actual production and growth. The huge capital inflows have not helped finance a higher rate of investment. America has been selling its factories and financial assets to pay for consumption.
It’s helpful to use a real means for measuring economic strength. Money coming here from overseas finances higher personal consumption. The steep decline in personal saving is a symptom of our spending, and along with that habit we have lower capital investment and a growing federal budget deficit. The U.S. economy has for years been the strongest in the world, leading the rest of the countries. Our Markets and Money newsletter routinely gets reader responses saying, in effect, “How dare you impugn the superiority of the American economy! How dare you!”
We’re rather thick-skinned so the insults bounce off rather easily. But “facts are stubborn things.” The fact that the U.S. economy has outperformed the rest of the world in the past several years is easily explained. Our credit machine has been operating in overdrive nonstop.
It is geared to accommodate unlimited credit for two purposes— consumption and financial speculation. Let’s look at these two things a little more deeply. Credit is not the same thing as production, despite the fuzzy logic you get from the financial media. There is a severe imbalance between the huge amount of credit that goes into the economy and the minimal amount that goes into productive investment. Instead of moving to rein in these excesses and imbalances, the Greenspan Fed has clearly opted to sustain and even to encourage them. Today it is customary to measure economic strength by simply comparing recent real GDP growth rates. It is pointed to as proof and applauded by U.S. economists when U.S. economic growth outscores Europe— like some kind of dysfunctional futbol match.
Financial speculation is equally unproductive. An investor puts up capital to generate a sustained and long-term growth plan. For example, buying and holding stocks is a form of investment and a sign that the investor has faith in the management of that company. peculators don’t care about long-term growth. They want to get in and out of positions as quickly as possible, make a profit, and repeat the process. So speculative profits—especially those paid for with borrowed money—tend to be churned over and over in further speculation and increased spending. None of that money goes into investment in the long-term sense. The speculator is invested in short-term profits, nothing more. Even so, the speculator is today’s cowboy, the risk-taking, living-on-the-edge market hero willing to take big chances. He is seen as a guy with big stones because he’s staring the prospect of loss right in the eye.
Markets and Money