No. 807: Are We Economic Hostages to Foreign Countries?

The dollar is falling against foreign currencies. Our trade deficit has swollen to record levels. Foreign investors have bought large quantities of our government debt. With all these financial facts, it’s easy to get the idea that foreign interests are getting the best of our economy. In fact, some observers argue that foreign countries now effectively control our economy. Let’s see if this is a real concern of if it’s misplaced anxiety.

There are three economic concepts at work here: foreign trade, foreign investment, and the value of the dollar against foreign currencies, technically known as the exchange rate value of the dollar. Although each has its own identity, the three ideas are also fundamentally inter-related.

Start with foreign trade. For most of the last three decades, U.S. consumers have bought more foreign-made products and services than U.S. companies have sold to foreign buyers. That is, the United States has usually run a trade deficit, or, as some like to say, the United States has run up a lot of “red ink” in foreign trade.

Is this bad? Most people say ‘yes’, but reality is more complicated. The United States is the richest country in the world, by far, in terms of annual income. Our consumers have huge appetites for all kinds of products. It makes sense that many foreign companies will want to sell in our country and many U.S. consumers will find foreign-made products to their liking.

And although we do buy more from foreign countries than they buy from us, this trade deficit should be kept in perspective. While large in dollar terms ($600 billion), it is still only about 5 percent of our total annual income. It’s hard for me to believe 5 percent is driving the other 95 percent.

But, you might ask, doesn’t the trade deficit mean we’re effectively exporting jobs to other countries? If all the products bought from foreign countries instead had been purchased from U.S. companies, wouldn’t that mean more jobs for U.S. workers?

This reasoning ignores what happens to U.S. dollars paid to foreign producers. Eventually they end up as investments in the United States. These foreign investments, in U.S. manufacturing plants, office buildings, and stocks and bonds, in turn create their own jobs here at home. The major difference is the ownership is foreign. But this foreign ownership today accounts for less than 10 percent of all U.S. assets.

One kind of investment foreign owners can make is in U.S. government securities issued to cover federal borrowing. Some see trouble here, claiming foreign countries own such a large amount of U.S. government debt that they could inflict havoc on our economy if they decided to sell these investments.

Yet when this foreign investing is put in context, it seems much less ominous. Foreign ownership of U.S. government debt has increased by only 3 percentage points in the last five years, and almost 60 percent of privately held U.S. government debt is still owned by U.S. citizens. U.S. government debt accounts for less than 12 percent of all domestic debt. Although there’s been much hand-wringing about federal borrowing in recent years, total U.S. government debt (a.k.a., the “national” debt) as a percent of national income is lower today than in most of the 1990s.

What about the third concept—the dollar’s value against foreign currencies? Is it worrisome when the dollar’s value falls? Should our goal be a “strong” dollar?

These are two of the most misunderstood questions in economics. There is no “correct” value of the dollar. When the dollar’s value rises (the dollar gets “stronger”), foreign-made products become cheaper for U.S. citizens to buy, so the U.S. trade deficit increases and foreigners accumulate more dollars as investments.

The reverse happens when the dollar’s value falls. U.S. exports are now less expensive for foreigners to purchase, so the trade deficit falls and foreigners accumulate fewer dollars for purchases of U.S. investments.

So if you worry about the trade deficit and foreign ownership of U.S. debt, a weaker dollar is what you want. On the other hand, a stronger dollar will increase the trade deficit and foreign ownership of U.S. investments.

While there are many economic issues that may cause you to lose sleep at night, in this humble economist’s opinion, international issues such as foreign trade, foreign investment, and the dollar’s foreign exchange value shouldn’t be among them. Instead, I recommend you use your allocated “economic worry time” to focus on taxes, government spending, and using our resources to achieve the highest levels of personal satisfaction and business profits possible.

Michael L. Walden is a William Neal Reynolds distinguished professor at North Carolina State University and an adjunct scholar with the John Locke Foundation.