Radical Idealism

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 U.S. 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 expansion.)  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.