Protectionist rhetoric will only accelerate the dollar’s slide

Buchanan’s recent attempt to
diagnose the sinking dollar
demonstrates that ignorance of basic economics is
not limited to the left.  Buchanan
points out the plummeting value of the dollar relative to other currencies and
major commodities such as gold (up 24% this
) and oil (up over
50% in 12 months
).  He then declares
that “the prime suspect in the death of the dollar is the massive trade
deficits America
has run up” to “maintain her standard of living and to sustain the American
Imperium.”  This diagnosis offers a
tantalizing glimpse of the truth, yet shatters it with protectionist bromides.

First, let’s deflate the protectionist rhetoric.  What are trade deficits and surpluses?  

A trade deficit means that in sum, American dollars are going
abroad in exchange for foreign goods.  Consider what this means.  If foreigners never cashed in those dollars,
Americans would essentially be getting foreign goods free of charge.  Protectionists like Buchanan
condemn this as “borrowing” but this is actually a form of investment – both in
industry and in the U.S. dollars.  Foreigners
have been investing in the U.S.
for decades for two primary reasons: the superior returns due to the growth
potential of American capitalism, and the dominance and (relative) stability of
the U.S. dollar, which made them useful as a means of exchange apart from their
purchasing power of U.S.
goods.  Americans are not living “beyond
our means,” as Buchanan claims, – we are simply a
more profitable investment, with a more stable currency than the foreign
investor’s own countries.

A trade surplus on the other hand, means that in sum, U.S.
goods are being sent abroad in exchange for foreign currency.  A trade surplus is a form of investing in
other countries, since (fiat) foreign currency is only worth the foreign
capital it can purchase.  This happened
after World War II, when the U.S.
sent capital to shattered foreign economies and reaped returns as the value of
their economies – and thus their currencies grew.

So are trade deficits preferable to trade surpluses?  In a narrow sense, yes.  A nation that has strong economic prospects
will attract foreign investment and therefore experience trade deficits.  Conversely, when the domestic economy is
stifled by regulations and monetary manipulations, investors will send their
savings abroad and the country will run a trade surplus.   (This
explains why the U.S.
deficit has consistently fallen during recessions and grew during periods of
However, the broader lesson is that trade inequalities indicate the net flow of
foreign investment, and the benefit of the inequality is ultimately validated
by the profitability of those investments.  Profitable foreign investment results in GDP growth and positive currency valuations,
whereas unprofitable foreign investment erodes economic growth and devalues the
currency of the investment’s recipient. 
Could a sufficiently large and wasteful investment be responsible for
the current dollar crisis?

A large part of the U.S.
trade deficit comes from the bonds (treasury securities) the U.S. government
has been selling to foreigners to finance the growing federal budget
deficit.  The value of these bonds depends
on both the strength of the U.S economy, and the loss of value caused by
expansion of the money supply.  When the
U.S Treasury sells bonds to individuals, it diverts savings from private
investments, and thus is a form of taxation. 
When it sells bonds to the Federal Reserve, it exchanges bonds for
dollars and thus is a form of monetary expansion (inflation.)  Additionally, when the government sells debt to
foreigners, it creates a liability against the U.S. economy.  Foreigners buying deficit debt are in essence
betting on the ability of the government to provide a return on the investment
in the form of positive economic growth. 
What happens when the investment fails to turn a profit?

The primary reason for the $9 trillion federal deficit is
the so-called “War on Terror,” including the spending on Homeland Security, Afghanistan, and Iraq.  Unless you believe these funds averted an
economic meltdown due to terrorism, these funds represent a near-total
loss.  Tanks, bombs, and bureaucratic
paper-pushers consume vast funds yet aside from military contractors, they
contribute nothing to the economy.  This
economic destruction is one of the biggest reasons for the declining
dollar.  (Perhaps the major reason is the
credit bubble created by the inflationary policy of the Fed since the early
2000’s, which is now collapsing and making the economy less attractive as an
investment target.)

The falling dollar will make it increasingly more expensive
for the U.S.
government to accumulate more debt. 
Eventually, it will be forced to either cut spending, explicitly shift
costs to U.S citizens by increasing taxes directly, or (most likely) to
increase taxes through higher inflation. 
Investors have already anticipated this and flocked to other currencies
and gold as a refuge.  The slide will
likely continue until some kind of budget reconciliation is evident.

The overwhelming response to the problems created by the
government’s financial irresponsibility has been to call for more protectionism,
as Mr. Buchanan is doing.  Because it creates barriers to trade and
investment, protectionism makes the U.S. dollar less valuable to both foreign
consumers and investors, thus accelerating the fall of the dollar.  Investors have certainly anticipated this as
well – but don’t blame them for betting on the gullibility of Americans to the
protectionist rhetoric of economic ignoramuses like Paul
Krugman and Pat Buchanan.

If we can avoid the protectionist trap and reconcile the
budget, the falling value of the dollar will eventually attract investors and stimulate
exports.  As the developing world becomes
richer and freer, the U.S. dollar is unlikely to enjoy the unchallenged superiority
it once had, but maturing foreign markets will attract products and services designed
in America,
and we will once again become a recipient of foreign investment.  Free markets and American ingenuity made the U.S. the greatest
economy in the world, and they are the only way we will keep it that way.