What came first, the rising U.S. trade deficit or the soaring amount of foreign investment in the United States? It’s a classic chicken-and-egg question.
And it’s timely because recent changes in the value of the dollar alter the incentives for both trade and investment. Trade and investment flows are highly related, but few people understand the links.
Consider two descriptions of our country’s economic position:
• An Insatiable Consumer. The United States is a high-consumption, low-savings nation, with high-cost manufacturing. Therefore, we import a great deal and export little. This pumps dollars out into world financial markets — dollars that do not come back through the buying of U.S. exports. The only option left to other countries is to take those dollars and invest them in the United States. We thus enjoy a high level of consumption, which we finance by selling off increasing proportions of U.S. Treasury bonds, corporate stocks and bonds and real estate to foreigners.
• A Global Investment Haven. The world is a dangerous place for most savers. Households and institutions in Japan face deflation and a stagnant economy.
In Latin America and Russia, effective confiscation of savings by mercurial governments is a constant threat.
Russians with money to save know how unsound their nation’s economy is so they save elsewhere. Western European savers face sluggish economies.
The United States is by far the safest place to keep money.
Even when the U.S. stock market tumbles and our government deficit balloons, the United States offers unparalleled investment opportunities.
The first description is the standard portrayal for much of what has happened to the U.S. international financial position since 1980.
We have run persistent trade deficits and invested much less abroad than foreigners have invested here. The portion of the U.S. national debt held by foreigners rose substantially over the past two decades, as have foreign shares of U.S. corporate debt and equity.
Assuming this is the whole picture, however, is a mistake.
Yes, importing more than we export pumps dollars into world financial markets. And those dollars are available for foreigners to invest in the United States.
No one, however, forces foreigners to invest here. If there was no international demand for investments in the United States, a trade deficit would be short-lived.
For example, if we imported $200 billion in some period and exported only $150 billion, there would be $50 billion in U.S. dollars floating around looking for a use.
If not snapped up for investment, such an excess of unwanted U.S. currency would make the dollar decline in value compared to other currencies.
That would cheapen U.S. exports and they would increase. U.S. imports would be more expensive and they would decrease.
Any trade imbalance would correct itself.
The insight that trade imbalances ultimately cure themselves goes back 250 years to Scottish philosopher David Hume.
But the United States can run a persistent trade deficit only as long as others are willing to invest in our nation.
That willingness may stem from a view that the United States is a particularly good place to invest or from one that all other investment opportunities are even worse.
There is thus a feedback loop. Foreigners could not invest in the United States if dollars were not available from a U.S. trade deficit. But when foreigners invest available dollars, it short-circuits the exchange rate adjustment that would otherwise take place and enables a trade imbalance to continue, month after month, year after year.
How does this affect you? One constantly hears references to different companies, sectors or even nations being “competitive in a global economy,” but it is meaningless to discuss competitiveness without answering the question “competitive at what exchange rate?”
Minnesota soybean farmers are much more competitive with counterparts in Brazil now that it takes only 2.9 reals to buy a dollar than last fall when it took nearly 4.
Medical device manufacturers are more competitive with European firms now that it takes $1.19 to buy a euro compared to when it took only 85 cents.
This increased global competitiveness of Minnesota firms is largely due to changes in investment flows between the U.S., Brazil and Europe.
But the effects on profits and employment here in Minnesota will be real.
© 2003 Edward Lotterman
Chanarambie Consulting, Inc.