By Robert D. Atkinson
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The skyrocketing dollar will further increase the U.S. trade deficit and the hollowing-out of America's manufacturing base. In fact, 2022 is projected to set all-time records for the U.S. trade deficit ($1.2 trillion) and its deficit in high-tech goods ($236 billion). Indeed, America's expected trade deficit will equal 70 percent of Korea's GDP.
For more than three decades, conventional U.S. economists have waved away any concerns about the massive U.S. trade deficit, arguing wrongly that it stems principally from the lack of U.S. savings, strong U.S. economic growth or even superior U.S. innovation.
The reality is much simpler: America has run trade deficits every year since the 1970s because of a less than fully competitive U.S. economy (in part because other nations support their export industries with a range of fair, and sometimes unfair, policies) that has been cyclically weakened by an overvalued currency dragging down U.S. exporters.
With the rapid rise of the value of the dollar in the last several years, the inflation-adjusted trade-weighted value of the U.S. dollar is now higher than its past peak in 2003 (which preceded a massive decline in U.S. manufacturing jobs), and just 12 percent lower than the 1983 peak (which also was associated with significant decline in U.S. manufacturing).
An overvalued currency exacerbates the trade deficit. As one study by the U.S. Department of Commerce argued in the mid-1980s "a decline in the exchange value of the dollar would significantly improve the trade deficit." It was true then and it's even truer now.
Another study found that the effect of a rising dollar "is small in the short run but can become quite large as the dollar's strength persists." After three years of dollar strengthening America we are likely to see even larger effects.
Another study found that manufacturing investment declines with dollar appreciation, because a strong dollar reduces corporate profits, which in turn leads companies to cut capital investment in order to maintain price competition with imports. Not a recipe for long-term U.S. manufacturing competitiveness.
So what difference does it make if America runs big and growing trade deficits? There are three reasons. First, trade deficits create trade debt. In the first seven months of this year, Korean companies provided Americans with $25 billion more exports of Hyundai cars, Samsung phones and dishwashers and LG televisions than American exports to Korea.
As an American I say "thank you." But all Korea gets is an IOU for $25 billion. Those IOUs add up and at some point Korea and other countries will want to get paid in real goods and services, not more Treasury bills.
Over time, there are only two ways for America to deal with its massive trade debt. The first is to run trade surpluses every year, likely brought on by a massive decline in the value of dollar. The second and perhaps more likely, especially if other nations do not boost their currencies, is to default on the debt that foreign governments and other investors own from recycling their export earnings into U.S. T-bills.
The second reason the trade deficit matters is that it hollows out strategic export sectors. If the United States were running a trade deficit principally in industries like food and minerals there would be little concern.
Given U.S. natural resources these sectors could be revived with a weaker dollar. But the strong dollar has reduced U.S. companies' global market share in advanced industries, such as machinery, transportation equipment, computers and semiconductors.
Unlike for commodity industries, these losses usually inflict permanent damage, putting some companies out of business and reducing economies of scale and continual reinvestment of earnings in R&D for the others.
Given that the U.S. manufacturing base has already been shrunk because of past dollar booms, it's not clear it can survive many more of these dollar appreciation-manufacturing decline cycles without its manufacturing economy looking more like that of the U.K. and Australia.
Third, the high value of the dollar reduces the attractiveness of investing in the United States, something the Biden administration and Congress are expecting after the passage of the CHIPS and Science Act (which provides grants and tax credits to invest in semiconductor facilities) and the Inflation Reduction Act (which provides tax incentives for domestic clean energy production).
The strong dollar will reduce ― and possibly completely offset ― the value of these incentives, limiting foreign investment, something that is already near record lows. The high value of the dollar will, however, enable Korean companies in a wide range of industries to gain greater market share in the United States through increased exports.
To address this challenge, the Biden administration needs to immediately convene a modern-day "Plaza Accord" bringing together the world's major central bankers to agree to increase the value of their currencies. If not enough countries agree, the Treasury or the Federal Reserve should sell dollars to buy foreign currencies, pushing those currencies up against the dollar.
Unfortunately, the chances of the Biden administration doing this are slim. In preparation for the 2022 election, the administration hyperfocused on inflation, and a strong dollar reduces inflation.
Moreover, the United States keeps creating manufacturing jobs because for the first time, manufacturing productivity is growing more slowly than non-manufacturing productivity, meaning even if manufacturing output declines a share of GDP jobs can still grow. So even though U.S. manufacturing competitiveness will be eroding, the administration can point to stable or even growing manufacturing jobs as proof that its policies are working.
Of course this can't go on forever either, because eventually U.S. firms will lose so much global competitiveness that they go out of business or contract in scale, or move operations offshore.
But that probably won't be noticeable until after the 2024 presidential election, so the proverbial can will continue to be kicked down the road, with the only solution likely to be a financial crisis that finally brings America's trade into something resembling balance, and with it, finally, a realization that the U.S. economy is nowhere near as strong globally as the elites thought it was.
Robert D. Atkinson (@RobAtkinsonITIF) is the president of the Information Technology and Innovation Foundation (ITIF), an independent, nonpartisan research and educational institute focusing on the intersection of technological innovation and public policy.
