Dollar Daze

The dollar continues its steady decline in value and its steady march to the top of the news broadcasts.

“Dollar falls to new low against the Euro” blared the Associated Press on Wednesday. The decline is “driven primarily by concerns over the U.S. trade and budget deficits,” the AP reports.

Talk of trade deficits (search) and budget deficits (search) can make the eyes of even the biggest policy wonk glaze over. But understanding them properly is the key to understanding what’s going on with the dollar and what, if anything, the Bush administration and Republicans in Congress should be doing.

The current fear is that, given these deficits, U.S. policymakers will be tempted to lower the value of the dollar (search) — thus making U.S. goods “cheaper” in markets overseas (and thus better able to compete in the global marketplace) and making U.S. debt easier to pay off.

Running a deficit sounds bad — who wants to say he’s running a deficit in anything? But are all deficits alike? As it turns out, not really. The concerns that Washington is spending too much are real. It is and it needs to slow down. But the concerns over trade deficits, if author Andy Kessler (search) is to be believed, may be much ado about nothing.

Kessler is among the most astute observers of the global economy today. He has just published an important and entertaining new book, “Running Money: Hedge Fund Honchos, Monster Markets and My Hunt for the Big Score,” (search) a follow up to his best-seller "Wall Street Meat.” (search)

In “Running Money,” he recounts his days as a hedge fund (search) manager looking for companies with long-term growth prospects to invest in. What’s most interesting is Kessler’s take on the trade deficit.

“Since the Industrial Revolution,” he writes, “a new twist has been added to the economic system. Since the birth of the personal computer, companies can focus on thin slices of intellectual property, which can have very high… [profit] margins.”

And it’s not just in the computer realm: pharmaceuticals, biotech, cell phone chips, industrial design, Hollywood and the New York-LA-Nashville music world, anywhere intellectual property (search) is developed. These are high margin businesses today.

What does this have to do with the trade deficit?

“The U.S. is a huge exporter of these pieces of intellectual property,” he writes, “but good luck finding it in government stats — it’s practically invisible.”

In an interview, Kessler told me “We are already moving low margin jobs overseas,” (remember the debates over outsourcing during the campaign?). “A weak dollar won't bring back manufacturing jobs. Twenty dollar an hour jobs in the U.S. vs. two dollars in China? The dollar would have to drop by 90 percent to make a difference. But fortunately, we are left with high margin, high profit intellectual property jobs. We don't make stuff anymore, we design it."

He exaggerates a bit – the U.S. is still a manufacturing giant. But he’s correct about long-term trends. To illustrate how this all works, he offers a helpful example in his book:

“A $300 Intel microprocessor and a $50 Microsoft operating system are exported from the U.S.; a $1000 [Toshiba laptop made in Japan] is imported, for a net trade deficit of $650. Yet on a profit basis, the U.S. clears 300 bucks, and the rest of the world maybe 50. Which economic system would you invest tin? Yeah, me too.”

The problem with all the talk of trade deficits is that it’s mostly a mirage. As the late great economist Herb Stein put it:

“Any apparent inequality simply leaves one country acquiring assets in the others. For example, if Americans buy automobiles from Japan, and have no other transactions with Japan, the Japanese must end up holding dollars, which they may hold in the form of bank deposits in the United States or in some other U.S. investment.”

Change “automobiles” to computers, DVD players, electronics and drugs that are designed in the U.S. but manufactured in Japan, China, India and elsewhere around the world, and you get to the heart of what Kessler is talking about. All those dollars that left the U.S. to buy foreign goods are also buying high-profit American intellectual property inside those goods. What’s more, all those dollars come back to American eventually. They are used to buy Treasury bonds or invest in the great American economic engine, chasing the growth that American companies — like companies nowhere else in the world — can generate.

But if the trade balance isn’t a concern, the federal deficits can be. While fears about budget deficits can be overblown, the Bush administration and Republicans in Congress could help dollar jitters by getting spending under control.

Why? Because smart currency watchers worry that Washington will be tempted to solve its future debt problems the way governments have since time immemorial — by printing more money. The resulting inflation would be disastrous for the American economy.

It’s time for President Bush to get serious about his campaign promises to get spending under control, and it’s time for Republicans in Congress to help. And a full-throated commitment by treasury Secretary John Snow to a strong dollar would help, too.

Nick Schulz is former politics editor of and currently edits, a site focusing on science, technology, economics and politics.