Dollar Suffering as Exports Eclipse Imports Douglas O. Walker Professor of Economics Robertson School of Government Regent University Virginia-Pilot—September 25, 2005

    For more than a decade, the U.S. economy has been the engine of growth for the world economy, transmitting prosperity to the world through its strong demand for other countries’ goods and services. However, the U.S. demand for imports has not been matched by demand for its exports, and as a result, U.S. external deficits are growing larger.

    Under the pressure of lagging growth abroad and rising oil prices, the U.S. current account deficit is now more than 5 percent of gross domestic product, representing a continuing flood of dollars out of the domestic economy and into coffers of foreign banks.

    This outflow cannot continue forever.

    The mounting deficits of the United States have been casting a shadow over the state of world economic balance for decades. These deficits arose when America’s shrinking merchandise trade surplus no longer offset the shortfall on other items on the current account and the outflow of capital to other countries. But for many years, the key role of the dollar as the reserve currency of the international monetary system allowed other countries to accumulate dollars willingly, and the rapid increase in world trade created a strong demand for dollars to preserve international liquidity. This liquidity demand for dollars, combined with changes in its international value and an increasing resort to official measures to manage widening imbalances, maintained some semblance of stability in international financial markets.

    Over time, however, the enormous and growing volume of dollars held outside the United States has added uncertainty to an increasingly unsettled international economic environment. Much of this money is not subject to any official control and is capable at any moment of generating large-scale capital movements that threaten world financial turmoil. Weak banking portfolios in Asia, a decline in major world stock markets, and misaligned and unstable exchange rates across the globe are major concerns with the potential to set off an international financial debacle.

    The danger is aggravated by the recent run-up in the price of oil, which boosted the cost of imports into the U.S. economy, weakened the economies of its main trading partners and accelerated the outflow of dollars.  

    There are now many more dollars abroad than foreigners want to hold, and they don’t want to accumulate more. Surplus dollars means a drop in its price – a dollar now costs less in terms of a euro, yen or pound than in the past. And if our balance of payments deficits continues, pressures against the dollar will inevitably intensify. This drop in the value of the dollar is necessary to shift demand at home from imports to domestically produced goods and to turn demand abroad toward U.S. produced goods.

    Fewer dollars flowing abroad for imports and more dollars coming home in exchange for exports would reduce the size of the dollar overhang. How fast and how far the dollar drops, and its effects on the United States and other countries, depends on actions taken at home and abroad.

    None of the alternatives are attractive. For the United States, if we do not take unwelcome steps to adjust our balance of payments, the huge amount of dollars held by foreigners could come home in exchange for a huge volume of U.S. stocks, bonds and other investments representing American productive assets. This means Americans would give ownership and control of many of our corporations and other property to foreigners. Our wealth becomes theirs.

    On the other hand, foreigners already own a considerable volume of American assets, and they could decide falling dollar assets are not worth holding. As they sold these assets, the dollar would collapse on foreign exchange markets, equities would crash on stock markets, and interest rates would skyrocket as bond prices fell. The federal government could not finance its deficit, and a national and worldwide crisis would develop. There is also the possibility that foreign governments could use their dollar holdings as a political bargaining chip against the United States.

    The rest of the world also must act. The tempo of world economic activity appears to be slowing. Without steps by other countries to improve their performance and buy U.S. exports, the positive impetus from strong U.S. import demand will end abruptly as outstanding dollar balances abroad simply become too large. Both the United States and the world economy would slip into full-scale recessions.

    The situation with regard to the dollar is very serious, much more serious than most people realize. We are living on borrowed money and borrowed time, and so is the wider world economy.

About the Author:
Dr. Walker  is a professor of economics in the Robertson School of Government at Regent University in Virginia Beach and serves on the board of directors of the World Affairs Council of Greater Hampton Roads.