Behind the falling dollar

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The dollar's continued slide has removed any doubt: Investors and economic leaders around the world fear the U.S. trade deficit has grown dangerously high.

They clearly worry that by buying so much more from other countries than they sell to them, and borrowing so much to pay for this overconsumption, debt-strapped Americans are starting to exhaust their creditors' appetite for more IOUs at today's low interest rates.

If nervous lenders stop accepting these IOUs so readily, and if the dollar starts being replaced as an international currency by counterparts that do not keep losing value (like the euro), the U.S. economy could sink into depression or worse, and take with it a world economy heavily dependent on exporting to the United States for its growth.

The dollar's weakness has revived interest in traditional fixes -- e.g., somehow raising the microscopic U.S. savings rate, and somehow stimulating faster growth abroad to suck in more U.S. exports. Yet restoring America's international finances also requires fundamental changes in U.S. trade policy. In particular, the United States needs to stop focusing so narrowly on signing trade agreements with low-income Third World countries --which make deep U.S. deficits practically inevitable -- and focus trade policy on higher-income countries with which better balanced trade is much likelier.

Trade expansion with Third World countries has dominated U.S. globalization policy since the end of the Cold War. Extending the North American Free Trade Agreement to Mexico, granting permanent normal trade status to China, and liberalizing trade with sub-Saharan Africa and the Caribbean Basin are just a few examples. Largely as a result, from 1990 to 2003, developing countries greatly increased their share both of total U.S. goods exports (from 24.75 to 44.88 percent), and of the much greater U.S. goods imports (from 30.47 to 50.82 percent).

Third World trade deals like the Central America Free Trade Agreement and the Free Trade Area of the Americas also dominate the Bush administration's future trade agenda. Even the current round of world trade talks expressly aims to create the greatest benefits for Third World countries.

By contrast, opening Japanese and European markets, where consumers can actually afford great quantities of U.S.-made goods, has been neglected in Washington for a decade.

Because of their often rapid growth (albeit from low bases), and need for the sophisticated goods in which high-income countries specialize, achieving balanced trade and even surpluses with Third World countries would seem easy for the United States. But because of great recent changes in world trade patterns, exactly the opposite is now true.

As much as half of all international trade in goods today no longer consists of finished consumer goods but of intermediate goods -- the component parts of these products, along with the industrial machinery needed to produce them.

This trade reflects the now common tendency of manufacturers to spread different phases of their production processes across the globe, and surging traffic among these internationally dispersed facilities.