According to the Federal Reserve flow of funds accounts (Release Z.1), the long-term rise in US exports was reversed decisively in the first half of 2009.

The following graph shows the dollar export trend in the context of rising and falling values of the US dollar versus currencies of major US trading partners.

	US Exports under Clinton, Bush, and Obama

The forces that seem to direct the volume of US exports and the relative value of the US dollar compared to currencies of US trading partners are as follows:

1. The US fiscal deficit: The relative value of the US dollar seems to be influenced primarily by the size of the US fiscal deficit. During the Clinton years, a Republican Congress combined with a moderate Democrat President, and falling defense spending, resulted in a fiscal surplus and a dollar rising in value against the currencies of trading partners. In the Bush years, following September 11, 2001, sharply rising defense expenditures — the result of two wars and the burden of continuing to act as the “World’s Policeman”, led to a return of rising fiscal deficits. In the first year of the Obama administration, all pretense of budgetary discipline was thrown to the winds, leading to even more rapid decline in the US dollar versus trading currencies.
2. Economic recessions/good times: The final year of the Clinton administration saw the collapse of the “dot.com” bubble and a mild recession which was reflected in a lower level of US exports. As good times returned during the Bush years, exports picked up substantially, spurred by a falling dollar. From the last quarter of the Bush term until today, the world entered a period of severe financial crisis, resulting in a sharp drop in US exports.
3. Anti-free-trade policies: Traditionally, the Democrat Party has been a close ally to trade unions and an opponent to free trade. Union pandering measures to restrict US imports were favored during the Clinton years, and currently by the Obama administration. This is part of the reason for the slow rise of US exports during the Clinton years and the sharp fall during Obama’s first year in office.

Of course, in addition to these factors, the principal force driving US exports is the value of the US dollar, which was rising during the Clinton years, and falling ever since the War on Terror started following the attacks of September 11, 2001.

The remarkable rise in US exports during most of the Bush years was undoubtedly due primarily to the fall in the US dollar, which, in turn, seems to have reflected the rise of US fiscal deficits driven by wartime budgets and, in the last years, pork-barrel spending driven by the Pelosi-Reid Congress.

The current collapse of dollar exports is usually attributed to a world wide recession, but distrust of the US dollar arising from Obama “spending is stimulus” measures and union-pandering certainly has had some influence.

A narrowing trade deficit

The counterpart to US exports is the value of the US dollar. A falling US dollar makes US products cheaper to foreign buyers, but also leads to US dollars being less attractive as a means of exchange for trade with the United States.

The combination of world wide recession and a falling dollar, so far, has led to a narrowing of the US trade deficit with the rest of the world. This means that there will a a diminishing supply of dollars in the hands of foreigners to buy US Treasury bonds to sop up Obama’s extraordinary “spending is stimulus” programs.

This decline in the value of the dollar, in turn, will make it more difficult to control the coming US inflation.

The rest of the world holds $16.8 trillion in US financial assets, according to Federal Reserve release Z.1, as of Q1 2009.

	Foreign trade based on dollars

Most of US financial assets held by foreigners are the result of the fact that the United States has been importing more from the rest of the world since 1971 than it has been exporting and that the sellers of foreign goods have been happy to receive US dollars in payment.

US financial assets held by the rest of the world consist mostly of debt instruments denominated in US dollars.

About $5.6 trillion is made up of direct investments and miscellaneous assets like real estate. Another $1.6 trillion is in US traded equities. The balance, about $9.6 trillion, is dollar-denominated debt owed to non-resident holders.

Although this “foreign debt” poses no real threat to US citizens, since it is denominated in US dollars, many people, including economists who should know better, think otherwise.

So, how long would it take to “work off” this debt?

What would happen if foreign exporters suddenly refused payment in dollars?

As long as the rest of the world accepts dollars in payment for exports, while the US continues to import more than it exports, the US trade deficit will continue to grow.

The decline in the value of the US dollar is nothing new. It has been going on for over half of century, since President Roosevelt rescinded convertibility into gold. The decline accelerated with President Nixon’s complete abandonment of the gold standard. Current variations in the value of dollar are hardly a blip in the long term trend. (Of course, other fiat currencies have also been declining in value.)

	The US dollar has declined since FDR abandoned the gold standard

Let’s pretend, however, that foreign exporters suddenly decide that they will no longer accept dollars in payment for their goods and rush to get rid of their holdings of US financial assets.

Here is what would probably happen:

• The value of the dollar against other currencies would plunge.
• US export goods would become incredibly cheap in terms of foreign currency. This would tempt foreign holders of US dollar debt to trade it for cash and buy export goods.
• By dumping dollar bonds to buy export goods, interest rates on US bonds would soar as prices fell. This would tempt some foreign holders not to sell.
• American importers, unable to pay in dollars as in the past, would need to borrow foreign currencies to import essentials like oil. Imports of “non-essentials”, like plastic dolls from China, would drop. Oil prices would rise. Americans would use their cars less.
• Foreigners holding dollar assets would find that the only way to get rid of the now-unwanted dollars would be to use them to buy non-financial assets from Americans (such as real estate and export goods). Dollars are legal tender in the US. There is plenty of US real estate and other non-financial assets to absorb the accumulated trade deficit.
• US exports in Q1 2009 were running at an annual rate of $1.5 trillion. At this rate, it would take a little over six years to “work off” the dollar-denominated financial debt due foreigners by selling them US goods and services. Of course, if the rest of the world was really anxious to get rid of their dollar debt, they could buy US export goods at a faster rate, while rushing to buy US real estate and making direct investments in US businesses (which by now would be humming along quite nicely to supply the booming export market.)
• Faced with soaring prices of oil and the inability to pay in dollars, the US would suddenly forget the “green dream” of wind farms and bio-energy and rush to drill in the Gulf of Mexico, while building nuclear plants in every state.
• As foreigners got rid of US financial assets, a major source of credit card financing would dry up. Americans, by necessity, would become thrifty.
• As a major source of easy credit disappears, corporations would be forced to turn to old-fashioned methods of equity financing. Stock buybacks would be a thing of the past. Stock prices would fall — effected by rising interest rates.
• Foreign exporters, faced with falling demand from the United States that now lacks the currency with which to pay for their products, would have to lay off workers, while employment picks up in the United States in the export sectors. Foreign governments might even seek to boost the dollar.

In other words, if the rest of the world were suddenly to turn against the dollar, the trade deficit might be eliminated in a few years, causing a boom in industrial production and real estate in the US, radical changes in economic behavior, and less employment in former exporters to the US.

What could cause this to happen?

The easiest way to destroy the credibility of the US dollar would be to jack up government spending to the point of bringing on hyper-inflation. In other words: just follow the current policies of the Obama administration.

However, there are countervailing forces that make the above scenario unlikely:

	US Senator Al Franken (D-Minnesota)

• The US is still a representative democracy: Despite the bizarre seating of the not-so-funny comedian Al Franken as a US Senator and the presence of representatives of “safe districts” like Nancy Pelosi and Barney Frank, the public can still be counted to turn away from its leaders, once the “misery index” gets above 15%. Since unemployment is expected to surpass 10% soon, while even modest recovery should send inflation above 5%, the current government is likely to be voted out of office once the public finally understands that Obama promises have been false. Just as in the days of Jimmy Carter, a return to conservative government will restore confidence in the dollar, as steps are taken to curb inflation and reverse Obama policies.
• A cheap dollar will boost American exports: As foreign factories cut back production to meet declining US demand, there will be pressure to accept payment in dollars, as before. After all, many countries have dollar balances, while balances in other currencies are far smaller. Because the value of the dollar has fallen, the value of goods that can be purchased with a dollar will have increased. As foreign unemployment rises, the urge to return to the dollar will also increase. A stronger dollar means not only more sales for foreign factories, but less competition from US exporters.

This “thought experiment” shows that fears of America’s children and grandchildren having to work for years to pay off debt to foreigners are unfounded.

The trade deficit would quickly disappear in an extreme inflationary environment. The system has self-correcting mechanisms.

Illustrations: Wikimedia Commons

Federal Reserve flow of funds table F.107 (Rest of the World) showed that foreign investors — that for many years had been the primary support of US bond and commercial paper markets — were conspicuously absent.

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In 2006 and 2007, the net annual flows of foreign investment into US financial assets were $1,831 billion and $1,685 billion, respectively. In Q1 2009, these flows, on an annual basis, had fallen to only $14.4 billion — down 99.2% from the 2006 levels.

These foreign investments, largely the result of the continuing US trade deficit with the rest of the world, have been the essential element in financing US government fiscal deficits, residential mortgages, commercial paper (credit cards, auto loans, etc), and corporate bonds.

Foreign holdings still at all time high

However, despite the retraction in Q1 2009, foreign investment in US financial assets is actually at an all time high. Foreigners simply can not get rid of their massive holdings of US financial assets over night.

Federal Reserve flow of funds table L.102 (Rest of the World), shows foreign investment in US financial assets as $16.8 trillion in Q1 2009, compared to $16.0 trillion in 2007 and ‘only’ $7.7 trillion in 2002.

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The trend indicated by flow of funds table F.107 is a movement from financial securities and bank deposits into direct investments and “miscellaneous assets”, such as real estate. This is a logical reaction to the profligate financial behavior of the Pelosi-Reed Congress and the Obama administration.

The world votes on Obama’s ’spending is stimulus’ plan

Inflation is now widely feared and financial assets like bonds and commercial paper do not offer protection.

As the Obama administration moves forward into even greater deficit spending with its trillion dollar health plan, it would be reasonable to expect foreigners to continue to move away from conventional financial assets, seeking safer havens.

This will drive interest rates upwards and bond prices down, making economic recovery more difficult. Corporations that continue to borrow to support stock buybacks will eventually pay the price — or at least, shareholders will.