So, the foreign exporters are getting a bunch of US dollars. They're not spending them on US goods and services - if they were, we wouldn't have a deficit. What are they doing with them? Well, they're using them as currency among themselves. Some nations use USD as currency directly, others depend on it for purchasing oil, which is traditionally sold in terms of the USD. The rest of it? Used to purchase US government debt. The big debt holders are Britain, China and Japan, but there are scores of others holding onto US debt in smaller quantities.
That works great for us - we get a whole bunch of stuff from the foreign countries AND our government gets to spend what it wants without having to worry about covering expenses with tax revenue. It works great for the exporters too - they get a huge market for the stuff that they make, and they earn interest on our debt. Two great ways to build a national economy. As long as the US economy grows quickly enough that we don't get strangled by the interest payments on the debt (and so far it has), we're all set.
There's a crucial dependency here though - the value of the US Dollar. A few thoughts there:
- I believe that some countries, notably Iran, are now pricing their oil in Euros rather than USD, bolstering the Euro and weakening the dollar.
- If our current economic retraction lasts a while, our GDP growth won't continue to pace the interest on our debt, meaning that the overall percentage of the national budget that goes to interest will rise, at the expense of other programs, or even more debt (a vicious cycle).
- If the Fed attempts to inflate their way out of the current situation (i.e., keep printing money until we recover), we're likely to see overshoot inflation, where the economy has recovered but the value of the dollar continues to fall.
We could become like Iceland - unable to afford outside goods, struggling to pay for even basic necessities like oil for transport and heat, and with all the other bad side effects of runaway inflation - difficulties for fixed income earners, an even worse credit collapse, etc.
The Austrians, eternal enemies of easy money, are already worried, telling everyone that the deflation we're worried about now is way better than the alternative. Not sure how serious it is yet (what do I know really), but I'm certainly worried. I might be motivated to be the first rat off the ship, running to durable goods (dare I say gold?) at the first sign of inflation's return?