Matt’s also taking requests these days, and his commenters ask him for a discussion of the dollar, and relatedly, of the structure of the economy. Matt does a good job responding, especially for someone who doesn’t really spend that much time writing on macro issues. Bravo.

I want to add just a few thoughts. Matt writes:

Usually a trade deficit leads to a weak currency which leads to a reduction in imports and a rebalancing of the deficit. But because foreigners were buying American assets, it didn’t happen, and Americans kept buying foreign-made goods (indeed, this is part of the reason the PRC was investing in so many American assets) and the deficit stayed high.

More recently, this process has halted. The dollar has declined in value, our imports of manufactured goods have slowed down, and we’ve started exporting more. Indeed, employment in the exports sector has offset a ton of the lost jobs in the building trades and prevented our economic problems from being worse than they were. Our trade deficit remains large mostly because we import so much oil (oil-exporting countries tend to plow the money back into western assets)…

There are some important complications to this story. In investing in the American deficit, a number of countries have accumulated enormous dollar reserves–China and the Gulf nations, especially. China doesn’t want the dollar to appreciate much against the yuan because it wants to preserve its trade advantage, but it also fears a large dollar depreciation because it doesn’t want to wipe out the value of those reserves. As such, they’ve maintained a peg against the dollar, as have many Gulf nations. Their reserves continue to grow–very rapidly–which presents a number of problems.

One, it makes the resolution of our trade imbalance more difficult. Two, it means that pegged nations essentially import American monetary policy. That policy has been very loose of late, and therefore not at all appropriate for places like China and the Gulf that are enjoying booming economies. The result has been global inflation, which has then been exported back to the United States. So while recent shifts in the dollar and in trade patterns have helped to address our trade deficit, major imbalances remain. It’s very difficult to see how they’ll ultimately come unwound; that’s going to be one of the big international economic challenges of the next decade.

Next, Matt writes:

In the long run, I think we should expect Americans to continue manufacturing goods. The idea that manufacturing was shedding jobs primarily because of trade with low-wage countries is something of a misunderstanding. There’s less cheap labor in Europe than in the USA but there’s plenty of manufacturing over there — rich countries just tend to manufacture higher-end goods. Even during the manufacturing drought, Americans were still “manufacturing” plenty of buildings. But the economics of cheap mortgages + construction boom + strong dollar + large trade deficit weren’t sustainable over the long run and now we need to rebalance toward manufacturing fewer buildings and more stuff to sell abroad.

One important thing to note about manufacturing is that even before the recent dollar decline, output was stable–growing actually. As a nation, we still have enormous industrial capacity. What we don’t have much anymore is manufacturing employment, because the labor-intensity of manufacturing has steadily fallen.
That’s bad for folks who used to work in huge, labor-intensive industrial plants, but it’s nonetheless the case that we remain plenty capable of producing goods, and a lot of them.

But there is an interesting shift taking place. Increases in oil prices have made international shipping more expensive. The result is renewed interest in localized production of some goods. Combining shipping costs with some minor exchange rate adjustments and inflation and wage growth in emerging markets, the stage is set for a pause, and perhaps a reversal, in the international dispersion of industrial production.