Sunday, October 19, 2008

Dealing with the Economic Crisis: Get Foreigners to Buy American

As a debtor nation entering a potentially severe recession, the United States has to figure out how to repay its debts. Foreigners won't finance America indefinitely, especially as its economy slows down. For now, with the dollar continuing to serve as the world's reserve currency, foreign sources of capital have little choice but to keep the U.S. afloat. However, relying on being the provider of the world's reserve currency isn't a sound long term economic strategy. In the early part of the 20th century, the British pound was the world's reserve currency. But fighting two world wars required an enormous amount of debt, making Britain's balance sheet, circa 1945 look seriously subprime (kinda the way America's balance sheet looks today). America's forgiveness of Britain's Lend Lease debt did much to help keep the U.K. afloat, although by then the dollar had gained ascendancy over the pound. However, the U.S. cannot expect any of its current creditors to be so generous. America will have to work its way out of its problems.

Getting foreigners to finance America requires that there be something here they want to spend their dollars on. In the past few years, that's consisted to a large degree of mortgage-backed securities and derivatives, a market that has now seriously dried up. For the moment, foreigners are buying lots of U.S. Treasury securities, as safe havens from the worldwide financial crisis. But that crisis will eventually be resolved, primarily through governmental action. Then, investor demand for U.S. Treasuries will drop, and interest rates on them (and all other debt in the U.S.) will rise. With the regulatory mess in the U.S. financial markets, it's likely that foreign investors will be cautious for years about buying anything other than plain vanilla American financial products like stocks and bonds.

Thus, in order to get foreigners to want to hold dollars and dollar denominated assets, increasing U.S. exports becomes critically important. The government should promote U.S. products in a way that plays to American strengths. The U.S. can't compete in the market for sheet steel or DVD players. But it can compete in the commercial aircraft market, the market for movies, television shows and other entertainment products, the sale and/or licensing of high tech products and processes, and the sale of agricultural products. America is creative and innovative, possessing enormous amounts of intellectual property, and has vast agricultural resources. Exploiting American economic strengths in foreign markets would increase real demand for dollars (as opposed to unpredictable short term flows in the capital markets), while strengthening the real economy.

The government continues to obsess over Wall Street and the financial crisis. President Bush and other world leaders have announced their intention to hold a summit after the presidential election this November, to discuss ways to improve the world financial system. That's nice, but it's more reactive politicking in response to news headlines. With the recession appearing ever more likely to be nasty, the government should focus more on buttressing the real economy. The financial system won't truly recover if the real economy slides into the doldrums. Getting foreigners to buy American will strengthen the real economy, and in turn, the financial system.

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