This from Money Morning:

Although still seen as the world’s economic superpower, the United States has found itself with a myriad of problems: Skyrocketing federal debt, growing annual budget deficits, an almost nonexistent personal savings rate, and the dubious honor of being the country with the largest current account deficit, of which trade makes up the largest part.

A trade deficit occurs when you are importing more than you are exporting — in other words, you are consuming more than you are producing. So the next time you are at Wal–Mart (NYSE:WMT) or Target (NYSE:TGT), take a look around. Just about everything you can purchase there comes from another country.

Economists are generally split over what the economic impact of a trade deficit is on a country. Those who defend running a trade deficit argue that when the United States sends money to another country for its goods or services, that country will take that money and invest it back into the United States, in one way or another. In economist Milton Friedman’s opinion, having a large trade deficit meant that your country’s currency is desirable. He believed that a trade deficit simply meant that consumers had an opportunity to purchase and enjoy more goods at lower prices; on the flip side, a trade surplus implied that a country was exporting goods its own citizens did not get to consume or enjoy, while paying high prices for the goods they actually received.

However, as those on the other side of the argument point out, countries with large and long-term trade imbalances also maintain a low national savings rate. Conversely, those countries with trade surpluses (such as Germany, Canada, and Japan) have a high national savings rate. Those arguing against trade deficits believe that gross domestic product (GDP) and employment will be pulled down by a large trade deficit over the long run. As goods flow into the United States from other countries, the country is losing opportunities to produce these goods domestically, which subsequently has an adverse effect on U.S. jobs.

Somewhere in the middle of these two sides is the world’s richest man, Warren Buffett. Buffett believes that, on a whole, trade is a good thing for America, but that over the long term, running “large-and-persistent” trade imbalances will be problematic for the United States.

Buffett realizes the importance of having the average American understand big economic issues, like the trade deficit. As a result, he wrote an article in 2003 for Fortune magazine, called “Squanderville vs. Thriftville.” This parable of sorts was designed to simplify for the readers the problems inherent in trade imbalances.

“Economics tends to put people to sleep,” Buffett told us when we sat down with him in his office at Berkshire Hathaway Inc. (BRK.A, BRK.B), where he is CEO and largest shareholder. “And I thought by creating a couple islands with inhabitants of quite widely different activities that it might get across a point that otherwise they get lost on.”

In Buffett’s story, he outlined two side-by-side islands: Thriftville and Squanderville. On these islands, land is the capital asset, and these primitive people only need food and produce only food. At first, the citizens of both islands work eight hours a day and produce enough to sustain themselves. However, as time passes, the Thrifts realize that if they work harder and put in longer hours, they can produce a surplus of goods and then trade what they produce with the Squanders. The people of Squanderville like the idea of working less — and all the Thrifts want in exchange for these goods are “Squanderbonds,” which are denominated in “Squanderbucks.”

As time goes on, these Squanderbonds begin to pile up and it is clear that the Squanders will have to put in double time to eat and pay off their growing debt. “Meanwhile,” writes Buffett, “the citizens of Thriftville begin to get nervous.

Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.”

“At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat — they have nothing left to trade — but they must also work additional hours to service their debt and pay Thriftville rent on the land that they so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest.”

In a nutshell: Buffett’s story illustrates that any short-term actions have long-term consequences that sometimes people don’t think about in the short run. This is true of the United States.

“Our country’s ‘net worth’,” Buffett writes in the introduction of his Fortune article, “is now being transferred abroad at an alarming rate. A perpetuation of this transfer will lead to major trouble.” And it may be more than just economic trouble. History shows that countries with similar trade and debt problems are fertile ground for political movements we’re not accustomed to in a democratic society.

In 2007, the total U.S. trade deficit was $738.6 billion, which was down 9% from 2006. Much of the decline could be attributed to a decline in the value of the U.S. dollar. The popular argument suggests that a lower dollar makes production of goods in the United States cheaper and therefore more attractive to buyers of U.S. goods overseas. Exports would go up. And in fact they are, each year.

Some would argue that the dollar is being kept weak to help close the trade gap.

“If I could finance all my own consumption today by handing out something called Warren Bucks or Warren IOUs and I had the power to determine the value of those IOUs over time, believe me, I would make sure that when I repaid them 10 or 20 years from now that they were worth less, per unit, than they are today. So any country that piles up external debt will have a great temptation to inflate over time, and that means that our currency, relative to other major currencies, is likely to depreciate over time.”

And this is just what the United States is doing. From November 2002 through August 2008, the dollar has fallen more than 50% against the euro. Some experts will argue that a weaker dollar benefits the United States — at least where the trade deficit is concerned.

What is not pointed out in this argument is that a falling dollar – paired with low domestic productivity – means that the country is consuming more than it produces. In that sense, since the dollar is losing purchasing power, Americans are paying more for these imports, and the rise in these import costs erases any sort of benefits the country would have seen because of a falling dollar. In other words, America is getting fewer goods for the same amount of money — but that isn’t slowing down the rate of American consumption.

“In the past six or eight years,” Buffett explains, “the United States has started consuming considerably more then it produces. It’s relied on the labor of others to provide things that are used every day. Because the country is so rich, this can continue for a long time, and on a large scale — but not forever.”

Buffett likens it to a credit card. “My credit’s pretty good at the moment,” he says, which usually draws snickers from the audience. “If I quit working and have no income coming in but keep spending, I can first sell off my assets and then, after that, I can start borrowing on my credit card. And if I’ve got a good reputation, I can do that for quite a while. But at some point, I max out. At that point, I have to start producing a whole lot more than I consume in order to clean up my debts.”

The trade deficit aside, Buffett doesn’t believe that the economic situation in the United States is as dire as many of the other experts with whom we’ve spoken have made it out to be. While he warns to not “bet against America,” because he believes that we have a healthy overall economy, what does keep the Oracle of Omaha up at night is the imbalance between imports and exports.

“The rest of the world is buying more and more of our goods all the time, but at an even greater rate, we’re buying more and more of theirs. More trade, overall, is good — as long as it’s true trade. If it’s ‘pseudo trade,’ where we’re buying but not selling, I do not think that’s good over time.”

This is why the U.S. trade deficit remains high. The United States is consuming more than it is producing. The country’s dependence on foreign oil, automotive parts, and cheap consumer products from China accounts for almost the entire deficit.

[Editor’s Note: The following essay was adapted from the book, “I.O.U.S.A.: One Nation. Under Stress. In Debt,”a companion offering to the critically acclaimed documentary “I.O.U.S.A.”]

Source: A Trip Down the Road to Squanderville

Wall Street bond traders estimate that the U.S. government will have to borrow a record $1.4 trillion during the current fiscal year – an unprecedented amount of debt that’s nevertheless needed to cover a federal budget deficit that’s expected to approach $1 trillion for the fiscal year, CNNMoney.com reported.

(The government’s fiscal year differs from the calendar year, and actually began Oct. 1. The $700 billion bailout plan was approved by the U.S. House of Representatives on Oct. 3, and was signed into law the same day by President George W. Bush.)

Experts predict that the government’s budget deficit will reach $988 billion for the current fiscal year – more than double the $482 billion estimate that the Bush Administration made in July. However, that estimate was made before the U.S. credit crisis worsened to the point that government leaders felt they had to take action. The controversial bailout plan was form that initiative has taken.

A deficit of $988 billion would be more than twice the record deficit of $454.8 billion, which was achieved during the budget year that ended Sept. 30.

Bolstering Banks

The main element of the bailout package – labeled a “rescue package” by the Bush Administration – was devised to bolster the balance sheets of banks, enabling them to resume lending. To that end, the Treasury Department is investing $250 billion into U.S. banks, a recapitalization strategy that U.S. Treasury Secretary Henry M. “Hank” Paulson Jr. and Federal Reserve Chairman Ben S. Bernanke have billed as being the best way to jump-start lending.

So far, the federal government already has used about $125 billion to buy stock in the largest U.S. financial institutions, including Citigroup Inc. (C) JPMorgan Chase & Co. (JPM), Bank of America Corp. (BAC), Wells Fargo & Co. (WFC), Goldman Sachs Group Inc. (GS), Morgan Stanley (MS), The Bank of New York Mellon Corp. (BK) and State Street Corp. (STT).

The remainder of the $250 billion that was allocated for financial institutions – between $124 billion and $131 billion – will be dispersed among smaller banks and thrifts, according to the rescue plan.

However, as a Money Morning investigative story revealed on Friday, much of that money is being used to finance takeovers of weaker banks, enabling big banks to get bigger, using taxpayer money to do so. [Editor’s Note: For a full report on this taxpayer-financed takeover binge – including which banks may be next on suitors’ shopping lists – check out this Money Morning investigative report, which includes commentary by Takeover Trader Editor Louis Basenese. This report is free of charge.]

Housing and Auto Woes

Of the remaining $450 billion, the government is looking to allocate between $40 billion and $50 billion to a tentative Bush Administration plan aimed at keeping as many as 3 million homeowners who are behind on their mortgages from losing their houses. Under that plan, which has been delayed by a series of legal snags and internal political debates, the money would be used to cover future losses on loans that are deemed eligible for federal support.

As currently conceived, the federal government would incur half the loss on a home loan if the mortgage company that controls the loan agrees to lower the borrower’s monthly payment for at least five years. On any given loan, the mortgage company would reduce the payment borne by the homeowner by writing off part of the loan balance, reducing the loan’s interest rate or changing other loan terms, sources told The New York Times.

While the Treasury Department is game to help U.S. homeowners, it’s been reluctant to extend direct support to U.S. automakers, which have also been hit hard by the financial crisis.

For instance, the government rejected General Motors Corp.’s (GM) request for $10 billion in assistance for its potential merger with Chrysler LLC after the Bush Administration decided it didn’t want to broaden its $700 billion financial rescue program to include industrial companies. President Bush also didn’t want to play a role in a GM-Chrysler merger that could cost the U.S. economy tens of thousands of jobs, The Times reported in a separate story earlier this week.

Instead of direct financing assistance, it looks like the Bush Administration will speed up the development of a $25 billion Department of Energy loan program that’s aimed at helping U.S. automakers develop more-fuel-efficient vehicles. The administration is also believed to have asked the U.S. Commerce Department to explore other ways that aid could be brought to the automakers – without expanding the scope of the bailout package.

The so-called “Big Three” automakers – GM, Chrysler, and Ford Motor Co. (F) – are in need of government assistance after being pushed to the brink of bankruptcy: Foreign competition and a slumping economy have combined to push vehicle sales down to their lowest level in 15 years.

GM has been in talks with Cerberus Capital Management LP about buying Chrysler since September. But potential investors in the deal have been hesitant to back the merger without the safety net of federal assistance, or a government guarantee of some sort. GM’s inability to secure financing at a time when credit is hard to come by and auto sales are in decline has left the No. 1 U.S. automaker with few options other than appealing to the government.

GM spokesman Greg Martin said in late October that the company had asked the Treasury Department to broaden recently enacted legislation – aimed at bolstering banks and financial institutions – to include auto companies.

In fact, General Motors Chairman G. Richard “Rick” Wagoner Jr. reportedly went right to Treasury Secretary Paulson Jr. and lobbied for the government to provide emergency financial aid to the Big Three via the $700 billion bailout plan.

Source: Bailout Plan Forcing U.S. to Borrow $1.4 Trillion, Creating a $1 Trillion Deficit