Reports today are indicating that our trade deficit shrunk to the smallest number in six years. That's good news, but may present an eventual problem for President Obama: A smaller trade deficit means foreigners have less extra money to loan back to us to fund our deficit spending.

The U.S. trade deficit plunged in January to the lowest level in six years as a deepening recession cut demand for imported goods at an even faster rate than for exports.

The Commerce Department said Friday the trade imbalance dropped to $36 billion in January, a decline of 9.7 percent from December and the lowest level since October 2002.

The trade deficit is, in large part, what allows the U.S. Government to engage in deficit spending. We buy more stuff from other countries than they buy from us, so U.S. dollars are flowing out into the world. The world, in turn, takes a lot of those dollars and loans them back to the U.S. Government by buying treasury bonds because they are considered "safe." So the massive federal government deficit is paid for, in large part, by foreigners lending their extra dollars to the U.S. Government.

The report above indicates the trade imbalance dropped to $36 billion in January. If you multiply that deficit by 12 months, you get an annual trade imbalance of $432 billion/year. That means the world cannot sustainably loan us more than $432 billion per year. They can for awhile, but not indefinitely. Eventually they will have loaned the U.S. Government all their extra dollars. And that $432 billion/year figure assumes that countries loan all their dollars to the U.S. Government. But they won't. They also use dollars to buy things from other countries, especially oil from the Middle East.

In reality, foreigners have been loaning the U.S. Government about $200 billion per year while domestic sources have provided about $250 billion per year. .

Even if the domestic savings rate increased to 8%, that'd only amount to about $830 billion per year. And even if the world increased its lending to the theoretical maximum sustainable amount of $432 billion/year, that would only come to a combined total of $1.26 trillion... That's well short of the probable $1.6 trillion budget deficit this year, and the $1.7 budget deficit for FY2010.

To add to that, and despite Secretary of State Hillary Clinton's trip to China to beg them to keep loaning us money, the Chinese Prime Minister is expressing concern:

China, the U.S. government's largest creditor, is 'worried' about its holdings of Treasuries and wants assurances that the investment is safe, Premier Wen Jiabao said.

'Of course we are concerned about the safety of our assets,' Wen said after the annual meeting of the legislature. 'To be honest, I am a little bit worried.'

So our largest creditor is expressing concern about their loans to the U.S. Government. That's not the news you want to hear just when you're anticipating asking for larger annual loans than ever before at a time when foreign countries are going to have fewer extra dollars to loan out.

So I continue to wonder where we're going to get the money the government is spending.

It's looking more and more like it'll be from the Federal Reserve. That is, "monetizing the debt" = "printing money" = eventual inflation. When recovery comes, the Federal Reserve will have to take money out of the system and/or increase interest rates to avoid that inflation. That will act to slow the recovery while making it more difficult for people to buy homes.

All this is to say that the CBO's estimate that the "stimulus" package would do more long-term harm than good seems entirely probable.