The Bernanke/Paulson Bet on the Dollar

The strategy which seems to be to let the dollar slide to bring the trade deficit under control seems to be working:

he U.S. trade deficit fell to the lowest level in 28 months as a falling dollar spurred U.S. exports to an all-time high. The deficit with China jumped to the second highest level on record as imports of toys and other goods surged despite a rash of safety recalls. ADVERTISEMENT The Commerce Department said Friday that the deficit for September dipped by 0.6 percent from the previous month -- to $56.5 billion. That was the narrowest trade imbalance since May 2005 and took economists by surprise. They had been forecasting the deficit would rise.

The improvement came from a 1.1 percent jump in U.S. exports, which climbed to a record $140.1 billion. The dollars' decline against many major currencies has made U.S. goods cheaper and more competitive in foreign markets. For September, sales of American-made cars, computers and farm products including corn, cotton, wheat and soybeans were all up.

Imports also rose in September, climbing by 0.6 percent to $196.6 billion, the second highest level on record. Imports of foreign-made cars, televisions and clothing were all up. Oil imports, however, fell by 0.8 percent to $10.5 billion, an improvement that is likely to be temporary given the recent surge in oil prices to close to $100 per barrel.

The deficit with China rose 5.5 percent to $23.8 billion, second only to a $24.4 billion deficit in October 2006. Imports surged to the second highest level on record, pushed up by big gains in imports of Chinese-made televisions, cell phones, computers and toys as retailers stocked their shelves for Christmas.

Those gains were occurring despite a string of high-profile recalls of Chinese products this year -- everything from toys with lead paint to defective tires and chemical-tainted toothpaste and pet food ingredients.

Through September, the trade deficit is running at an annual rate of $703.4 billion, down by 7.4 percent from last year's $758.5 billion. Analysts believe that surging exports from a weaker dollar will lead to a narrowing of the deficit for the full year, breaking a string of five consecutive records.

Critics of President Bush's trade policies say that even with the narrowing of the deficit this year, the imbalances are still running at unsustainable levels, forcing the United States to depend more and more on foreigners' willingness to hold dollars to finance the imbalances.

While a falling dollar is good for exports, it raises worries that at some point foreigners will be less willing to purchase dollar-denominated investments such as U.S. stocks and bonds. Such a change in sentiment could send stock prices plunging and push up U.S. interest rates.

The administration scored its first congressional victory on trade this week when the House passed a free trade agreement with Peru. However, approval of three other deals with Panama, Colombia and South Korea are expected to face tougher challenges in Congress.

For September, America's foreign oil bill dropped by 0.8 percent to $10.5 billion reflecting a drop in volume. The average price for a barrel of imported crude rose to a record $68.51 in September and is expected to climb even higher with the recent spike in spot oil prices, which traded this week near $100 per barrel.

The imbalance with the European Union dropped a sharp 37.1 percent to $6.4 billion. The dollar has fallen to record lows against the 13-nation euro currency, which means that U.S. products are cheaper in those markets while European goods are more expensive for American consumers.

The deficit with Canada, America's largest trading partner, dropped by 3.2 percent to $4.9 billion while the imbalance with Mexico fell 9.3 percent to $6.3 billion.

As the current accounts deficit shrinks, gross national product rises. The danger in this play though is losing the soft power that came to the US through the dollar being the reserve currency of choice in the world. However, if the Euro begins to split that role with the dollar, this is not necessarily bad for us, as it will increase the EU's leverage worldwide, but at the same time foist more responsibility on them, as well as reduce their anxiety about US hegemony and hyper-power.

But what we really need to do to reduce the trade deficit is get serious about oil importation, which means ANWR.