Mister, can you spare a dollar?

Recent trends in the strength of the dollar are worrisome.

Dollar's Decline Is Reverberating by David Streitfeld Los Angeles Times 11/14/04

During a routine sale of U.S. Treasury bonds in early September, one of the essential pillars holding up the economy suddenly disappeared.

Foreigners have been regularly buying nearly half of all debt issued by the U.S. government. On Sept. 9, for the first time that anyone could remember, they stayed home.

"Thoughts of panic flickered out there," said Sadakichi Robbins, head of global fixed-income trading at Bank Julius Baer.

The foreigners returned in force at the next Treasury auction, and Sept. 9 was quickly dismissed as an aberration.

But the episode demonstrated how much the U.S. economy is dependent on other countries to bankroll its free-spending ways. That fragility is becoming even more precarious because of recent declines in the U.S. dollar to multiyear lows, some economists say.

All of this is connected with the chronic trade deficits the US has run for years.  One of the things virtually all economists manage to agree on is that those deficits are not sustainable forever, among other reasons because they rely on indefinite foreign financing, making the strength of the dollar dependent on those foreign nations' willingness to loan money to the US.  When that willingness slips, the dollar becomes vulnerable to yet another set of forces that the World's Only Superpower does not entirely control.

Streitfeld's article gives a glimpse of some of the risks:

Usually indirect bidders, which include foreign governments, are heavy buyers at Treasury auctions. This time, their purchases were less than 3%. Traders speculated that Japan was finally calling it quits.

What happened was never explained, but neither was it repeated.

"It turned out to be a fluke," said Kim Rupert, managing director for global fixed-income analysis at Action Economics, a consulting firm. "But at first blush, it was 'Oh my gosh.' "

This article from 2000 discusses the same problem.  This is not some issue that simply recurs with the business cycles.  It's a chronic problem that has been around for years: Unsustainable by Eamonn Fingleton American Prospect 08/14/00.

But the U.S.'s triumphalist economic view today is that "trade deficits no longer matter." This idea was once associated solely with the wilder shores of globalism. For example, it has long been a hobbyhorse of The Wall Street Journal's neoconservative editorial pages, and it achieved perhaps its most memorable articulation in a 1993 commentary by Kenichi Ohmae, a former McKinsey guru in Tokyo. "No one worries about trade balances between California and Texas," he said. "Why should they worry about the balance between the United States and Japan?" It was for comments like this that Michael Lewis dubbed Ohmae the "galloping globalist." These days, however, judging by the ennui with which papers like The New York Times and The Washington Post have treated the deteriorating trade trend, Ohmae's view has gone mainstream.

Is it really true that America's mounting trade deficits are not a problem? Hardly. The negative implications are legion. In fact, it may not be much of an overstatement to say that unless Washington can quickly reverse the trade trend--by exporting more and importing less--America's days as the world's leading economy are numbered.

Fingleton's article is focused more on describing the US trade deficit.  And he warned even then:

Sooner or later something will give, and that something is the exchange rate. If the past is prologue, the dollar will fall suddenly and precipitously, in much the way it did in the mid-1980s and early 1990s, two occasions when it lost half its value against the yen. (To pay for all those imports, Americans must sell dollars to buy the foreign currency necessary to pay for imports; the flood of dollars into the exchange market drives the value of the dollar down.) That we are close to a similar adjustment seems obvious given that--entirely overlooked by the American media--America's current account deficit last year hit an all-time record of 3.8 percent of gross domestic product, with preliminary indications that the deficit this year could exceed 4.5 percent. This compares with a previous record of 3.6 percent set in 1987.

Streitfeld's articles notes, "The current account deficit has risen from 1% of gross domestic product in 1990 to 5.4%."  So the problem has only become more severe in the intervening years.  Continuing with Fingleton:

Even putting aside worries about foreign-exchange rates, there is still this to consider: Every dollar of current account deficit the United States incurs represents another dollar of assets transferred from American to foreign hands. No one in America seems to have perceived how rapidly the country is going into hock to its major economic competitors. The most obvious manifestation of this phenomenon is the takeover of major American corporations by foreign interests. ...

The cumulative effect of all this is a dramatic diminution in America's economic standing on the world stage. While it may not be immediately apparent to voters or even to opinion leaders, it is obvious in national asset/liabilities figures published by the International Monetary Fund. These show that in the first nine years of the 1990s alone, America's net foreign liabilities ballooned from $49 billion to $1,537 billion.

Fingleton published a book on the topic in 2003.  This Web site has more of his description of the trade deficit problem: The Trade Disaster: A Primer 10/23/03.  I think we could say he's a "trade deficit hawk."

This doesn't mean that economic disaster is around the corner.  But it doesn't look pretty.  It's also worth keeping in mind that China contributes significantly to financing the US trade deficit.  If the neoconservative zealots succeed in setting them up as the new main villain in their new Cold War, China could decide that financing American deficits really isn't in their interests.

Even if the dollar rebounds in the short run, this is a chronic, long-term problem with very serious implications for the health of the US economy.