It's Exports, Stupid!

In his recent blog "When will recovery begin? Never" former Secretary of Labor, Robert Reich correctly pointed out that "consumers won't start spending until they have money in their pockets and feel reasonably secure." That won't happen, he says, because the old economy is broken and "cannot be sustained." Hence, the "Never" in his title. He looks for a "new economy" to emerge. "What will the new economy look like?" he asks. "Nobody knows."

Well, I do. The new U.S. economy will be driven by exports and increasingly owned by foreigners.

The U.S. economy is in crisis due mainly to three interrelated factors: too much household debt creating a crisis within lending institutions and a lack of aggregate demand from over-extended consumers. Measures taken by Washington to date have attempted to shore-up undercapitalized lending institutions and to supplement sagging consumer demand. These are appropriate, yet necessarily temporary, measures intended to keep the economy functioning until sustained private-sector demand is restored and household debt is reduced to sustainable levels.

Accordingly, the recovery will gain traction when those with money begin spending aggressively enabling those in debt to begin paying it back. Those with money today are mainly foreigners (Asians and OPEC) who also happen to be our largest creditors. Those in debt are American consumers, who won't be a force for economic growth until they pay down debt to reasonable levels.

This, then, is the surest road to recovery: As foreigners face up to the fact that they can no longer rely on over-extended, frightened, increasingly unemployed Americans to drive their economies, they will repatriate some of their dollar holdings to stimulate investment and consumption at home. Such repatriation is already underway according to Treasury’s latest TIC reports showing average net monthly TIC outflows of $65 billion during the 4 months ending in May, compared to monthly inflows averaging $52 billion in 2007 and 2008 -- a swing of $117 billion a month! Repatriation will drive the dollar down relative to creditor currencies making U.S. exports more competitive, imports more expensive. The yen is already soaring and the Dollar Index is off 11% from its March 2009 peak. The renminbi will rise when China so decides; moreover China is taking steps to internationalize the renminbi as an alternative to the dollar for trade settlements. The U.S. trade deficit, already narrowing sharply, will swing to surplus as foreigners buy bargain-priced American goods and services. (Yes, we have lots to sell: the U.S. is tied with Germany as the world's largest exporters. And, yes, exports are only 12% of U.S. GDP, yet, for example, 20% growth of a 12% sector adds 2.4% to GDP growth.) Vigorous U.S. exports will provide stimulus for U.S. employment, and trade surpluses will provide Americans a means of paying down foreign debt.

The U.S. foreign debt will be further reduced by foreigners converting their dollar-denominated debt into dollar-denominated assets (stocks, real estate) at bargain prices. Such foreign purchases will help sagging stock and real estate markets to rebound.

In one fell swoop, the devalued dollar will re-invigorate the American economy through increased exports (offsetting the negative effects of a flight from the dollar) and revived stock and real estate markets, while providing the wherewithal to pay down our foreign debt, restoring the U.S. economy to sustainable growth. This is nothing more than the usual, market-driven ebb and flow of international trade, an outcome our trading partners should be encouraged to embrace.

To be sure, such an outcome will pose challenges to fiscal and monetary policy by pushing up interest rates. However, as demonstrated by Asia following the "Asian 'Flu" of 1997-98, the advantages of a low-valued currency in stimulating exports ultimately outweigh the drawbacks of higher interest rates due to capital flight. We need to borrow a page from their playbook. The sooner exports take up the slack in the U.S. economy, the quicker Washington can stop pumping up the deficits with emergency spending.

The common mistake made by mainstream economists today is to overlook foreign demand as the primary source of sustainable U.S. economic growth, simply because international trade has plunged due to the financial crisis and the value of the dollar has been supported as a “safe haven.” However, the crisis and ‘flight to quality’ are abating, U.S. exports are bottoming and will strengthen as the dollar devalues further and foreigners rev up their domestic economies, becoming the new “engines of world economic growth.”

What Washington must do is stand aside let the market mechanism do its work — i.e. promote U.S. exports and avoid jingoistic "strong dollar" and protectionist policies or xenophobic restrictions on foreign purchases of U.S. assets other than for national security reasons.