The question comes to Mises.org:
“In his Mises.org article (posted October 29) entitled “Saving the Dollar from Destruction,” Hans Sennholz wrote: ‘Foreigners are financing the American purchase of goods and services, half a trillion dollars worth every year, which visibly sustain American standards of living.’ I have heard this countless times. But I do not understand how this works, or the mechanism by which it works. Sennholz also says: ‘foreigners are investing in U.S. Treasury obligations and dollar assets, trusting in the continuing integrity of the U.S. dollar.’ OK, so foreigners sell us goods, we pay them in dollars, and they keep the dollars. Why? Why not use them to buy Euros, or gold, or something else?”
They do use them to buy something else: Treasury securities, as well other “American” assets. What happens is that we buy more merchandise and services from them than they buy from us. Thus, on net we send them dollars which they then use to buy our assets of all types. As long as this continues we are acquiring goods in excess of what we produce, financed by the rest of the world (ROW). As long as they wish to acquire our assets for their goods, no problem. The trouble begins when they no longer wish to do so. At that point we must export more and/or import less. In any case our living standards go down.Worse, if they not only wish to quit financing our deficit, but cash in their American assets, they dump them on the market driving down asset prices. They then take the $ earned from the sale of the assets and dump them on the market for some foreign currency, their own or some other.
In any case the international value of the $ goes down. To what extent asset prices would fall (minor or a collapse) and the $ would depreciate (minor or a collapse) would depend on the extent of their flight from American assets. The only mitigating factor would be if the current account deficit were financing capital investment, either directly via imported capital goods, or indirectly by importing consumer goods that substitute for domestic production of consumer goods, which productive capacity were shifted to the production of capital goods. In that case, if the international deficit is being used to finance desired capital expansion; i.e., investment and not malinvestment, than it can be justified. If, as I suspect, it is being used to finance a consumption binge, than the seeds of destruction are being sown.
Posted by Bill Barnett
