




The micro view





The Economy is Not Zero Sum




So What do the Chinese do with Those Dollars?









Anyway, you can find more here at Cafe Hayek.



  1. earl:

    You know, you should really try sticking to things you understand. Say, not international economics.

    The first counterpoint to your argument is change in the US NFW position over the last 20 years -- say, 1985 on.

    The second is that the argument that a global savings glut / lack of strong investment opportunities has helped depress global interest rates and in particular, depressed domestic saving is anything but a "tenuous" argument. Viz Bernanke.

    Third, the problem w/ large amounts of foreign investment is we're selling lots of our future earnings to foreigners, and repayment may well depress future growth.

    Fourth, it *may* be rational to use cheap foreign capital to invest in America... were that what we're doing. I'm dying to see your argument that wasting several hundred billion dollars on a voluntary war and a massive drive up of housing prices / real estate is, in any way, going to increase future productivity in America. In other words, it's not investment spending, it's consumption spending.

    Five, we are consuming more than we produce -- that's why we are borrowing.

    Six, exchange rates are being propped by the Chinese government, most likely to prevent social unrest in China if their export market were to diminish. This is fine... as long as it continues. Were it to stop suddenly, ie were the Chinese central bank to stop taking large sums from domestic taxation and converting to dollars at a negative real interest rate, US interest rates would be forced to jump very rapidly in a short period of time in order to cover required spending. Hence the fear of a hard landing, not a soft one.

    I could go on, but your post essentially demonstrates a lack of knowledge.

  2. Kim Scarborough:

    This article (http://www.slate.com/id/2040/) also makes a good argument by analogy against trade deficit freakout.

  3. Duane Gran:

    Your essay sheds some light on the matter, but I still have trepidation about basing an economy on consumption. America produces much fewer durable goods than it used to and many people consider foreign re-investment to be a type of faux-wealth that could dry up rapidly if another currency becomes more attractive than the dollar.

    Should we be concerned that we manufacture very little? I tend to think so, but as long as other nations do the manufacturing at a fraction of our cost I don't see any way to change the course.

  4. JohnDewey:

    Do we manufacture very little in this country? or do we manufacture quite a lot? I tried to answer this by enumerating my purchases, after taxes and savings.

    U.S. goods:

    house (mortgage principal)
    house (maintenance and improvements)
    Ford pickup truck
    Honda Accord (assembled by American workers)
    toll roads

    U.S. services:

    mortgage interest
    health insurance/medical expenses
    auto insurance
    homeowner's insurance
    life insurance

    Foreign-made goods:

    household goods

    One important thing about foreign-made goods: only a portion of my purchase price actually goes out of the country.

    Most of the foreign-built items were shifted overseas a decade or two ago, with little impact to my income and positive impact to my standard of living.

    Why should I be concerned if 6% or 7% of our GDP is spent on net U.S. imports?

  5. RP:

    The Feds tax individual income, capital gains, dividends, and interest, on US citizens.
    The Feds tax US corporations, and US corporations arrange the books such that they have no/little taxable income.
    But the Feds cannot tax foreigners, nor Foreign Central Banks, on their investments, right?
    And if foreigners don't *consume* what they earn (i.e. they save and invest in other consumers), there is no/little
    income flowing back via US export sales.

    Therefore, I would suggest that the major problem will be that the Feds will eventually need to tax consumption
    (AARP...uh oh), or eventually inflate away it's debt (dollar value...uh oh), or Uncle Seymour will starve. Of
    course, we could always hope that foreigners suddenly match US consumption practices...but I wouldn't hold my
    breath on that.

  6. RP:

    Oh, and if you think this will end well (independant of national borders), you should google "telecom vendor financing in the late 1990s". It didn't end well for the financee nor financer. One day, we will talk about "FCB supplier financing in the 2000s".

  7. Aminorex:

    Something you may be overlooking: China is willing to accept dollars because (1) the dollar is historically stable, and (2) the dollar can be exchanged for what China wants. What does China want? Petroleum. Because the major petroleum markets are dollar-denominated, the demand for dollars is strong. What will happen when those markets diversify, and petroleum purchases are increasingly denominated in Euros?

    In order to keep the value of the dollar stable in the face of declining international demand, it will be necessary to reduce the money supply. An increase in import costs is guaranteed, but also a contraction in the economy. This makes domestic investment unattractive. An inflationary policy is likely, because devaluation is the only way to mitigate the vast debt which pervades the system. In combination, if the timing is poor, we have a perfect storm, insuring the flight of capital out of the U.S., in turn further devaluing the dollar, creating a forceful inflationary spiral. Increasingly, the bulk of investment is internationally mobile. When the interest of the investor is best served by a contraction of the U.S. economy, one may expect the U.S. economy to contract.

    Heroin is very pleasant while it is in good supply. It is when the supply is withdrawn that the painful consequences of the habit become evident. Venezuela is contracting in Euros today. Iran opens it's Euro-denominated bourse in March, at the same time that the Fed ceases to publish M3 numbers. I'm expecting a long, hot summer.

  8. Anon:

    You've discussed how well the US is doing without mentioning anything about the military grip it has on South America and the Middle East. I think accusations of ignorance are well founded.

    You claim the US is the strongest economy in the world but that is based on GDP. Do you think GDP is the best evaluation of an economy and if so, do you think it's a worthy measurement? Compare it to something like UN 'quality of life' measurements or unemployment rates, or anything.

  9. grumpY!:

    in the immediate term, a consumption based economy producing trade deficits need not cause concern.

    longer term, we are injecting a great deal of volatility into the global economic system by exporting our imbalances to what will soon be the world's largest economy. stephen roach has written ad nauseum on this, as has bill gross, etc.,. this isn't the largest system issue - one or two serious dollar crises can correct this imbalance as china's dollars drop in value. the largest issue us that our economy cannot continue to progress as a nation that exports manufacturing and high-margin services (the outsourcing trend in finance, software, semiconductor research and even biotech has gutted any argument that we are the only "thinkers"). this is a credit-card binge on a national scale. and like any credit binge, lenders will always keep the credit going, but only as long as it is to their advantage.

    one day china's domestic market will be larger than the US export market. when that happens, they will dump their dollars whenever they feel like making the US economy scream (to borrow a Nixon term about his designs on Chile).

  10. Doctor:

    Err, why is gasoline among US goods? Oil is THE reason for the trade deficit, and the cost of energy in production and transportation is hidden in more or less everything that's US-made.

  11. John Dewey:

    "Err, why is gasoline among US goods? Oil is THE reason for the trade deficit"

    Crude oil is a raw material, most of which is imported. Gasoline, diesel fuel, jet fuel, synthetic rubber, plastics, and hundreds of other products are manufactured goods produced from that raw material. Most of those manufactured goods used in the U.S. are manufactured at U.S. plants.

    I'm not sure that most economists would agree that "oil is the reason for the trade deficit".

  12. Andre Kooy:

    Dear sir,
    I can show you where's the debt. Take your Fred example. If he's the average American, he then makes 50,000 USD a year, but spends 53,500 USD.
    Hence the trade deficit, which is just the difference between what you make (GDP, or Fred's 53.500) and what you spend. The difference is currently 7% of GDP (or 3,500 USD for Fred).
    Hence, Fred has 3,500 USD new debt this year, on top off all the debt he already has. Fred also needs to pay interest over his debt. If you spend more every year than you make, that is your personal trade deficit, and you accumulate debt, that needs servicing (= pay interest, or dividend when the Chinese invest in an US company; and the Chinese and other foreigners only do that to get more USD out than they invest now!)

    So, the current account deficit(currently almost identical to trade deficit) means that the US are accumulating more and more debt (or, in macro economic terminology: the Net International Investment Position is negative and growing).

    This means that the US needs to pay more and more interest. High consumption in the current years needs to paid off, with interest, by future generations.

  13. W. Raymond Mills:

    The trade deficit harms U. S. busineses.

    If we had equal trade between the U. S. and the rest of the world, we would still have plenty of competition for U. S. businesses. The only firms that would survive are those that could sell on the international market - BUT with equal trade the U. S. would not be financing the improvements of competitor businesses.

    Japan firms stay ahead of U. S. auto producers because they have annual profits from selling in the U. S. to fund their research.

    At the moment, U. S. auto firms cannot compete.

    The temporary solution is to reduce imports from the 5 countries that are responsible for 60% of the U. S. trade deficit. Tariffs should be applied to ALL imports from those 5 countries, in a gradually increasing rate, until our imports shrink to the level more nearly equal to our exports.

    This is not protectionism, as traditionally defined, because it does not discriminate among products. It discriminates among countries. For a valid reason - to get closer to balanced trade.

  14. Ames Tiedeman:

    The trade deficit is a debt. We cannot get the dollars back we have spendt unless we export to get them back. It is called an external debt for a reason. It is called a current account debto for a reason.

  15. Andre Kooy:

    In response to W. Raymond Mills:

    Please note that this will help some US businesses, however hurts all US consumers: they have to pay more money for the same products. Tariffs generate in total a loss to the economy imposing them: the big advantages for some businesses never outweigh the total of small losses to all consumers.

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  19. Fast Eddy:

    What nonsense. "But the fact that the Chinese choose to spend their dollars on debt securities does not mean that the trade deficit is causing the debt."

    We buy perishable goods from China, they buy our debt. In 20 years the Chinese made TV is worthless, in 20 years they still have US dollars. The dollars are inflated by the printing of new dollars but if we print too many they can buy US businesses and other hard assets and dump Tbills.

  20. May Xu:

    How Bastiat Toppled the “Balance of Trade” Bugaboo

    Protectionists of all stripes often rail about trade deficits. An unfavorable balance of trade. One of the catch phrases of these people, because at some level they realize the value of trade, is that they want "fair trade." That's just protectionism under the guise of being pro-free trade.
    Those dastardly Chinese just don't play fair!
    Balance of trade! That old bugaboo.
    Ironically, proponents of free trade often make the same mistaken argument. They support free trade because they believe that their country will be a winner. They will win the "trade wars" and have a favorable balance of trade. The country's exports will exceed its imports which will be good for everyone.
    Frederic Bastiat vs. the Protectionists
    The Trade Balance and the Businessman
    The theories of the free traders are attacked as valid only in theory by the protectionists, but, asks Bastiat, "do you think the account books of businessmen are valid in practice?"
    Throw it into the sea!
    Indeed, we could go further and argue that if we need a balance of trade between countries, why not between the states? Why shouldn't New York insist that the value of movies it imports from Hollywood be balanced out by an equal value of manufactured goods exported to California? To ask the question is to see its absurdity.


  21. May Xu:

    Is There an Unfavorable Balance of Trade?
    Economists who believe in the market economy seldom have kind words for the ideas of the late John Maynard Keynes, and understandably so. Keynes, who did so much to make inflation a popular policy worldwide, was no friend of the free market. Scattered here and there in his voluminous writings, however, are passages with which free mar­ket advocates can wholeheartedly agree. This one in particular deserves to be carved in stone and enshrined forever:
    The ideas of the economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly under­stood. Indeed the world is ruled by little else. Practical men, who believe them­selves to be quite exempt from any in­tellectual influences, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back.¹
    Today it seems that defunct economists and academic scribblers are making a dramatic comeback. Economics has become burdened with foolish notions that were once thought to be discredited. Some of these notions are put forward as if they are imaginative, new discoveries; too many are designed to turn the clock back to the days before free trade unleashed the creative energies which have built the prosperity of Western civilization.
    Twin Obstructions
    A leading illustration of this point involves the twin concepts of "balance of trade" and "balance of payments." These two concepts, which sound innocuous in name, often form the basis for erecting barriers to foreign goods. With the demand for "protectionist" legislation on the rise throughout the world, we can expect to hear more about them in coming months.
    How are these terms defined? The "balance of trade" is considered to be the difference between the money value of a country’s merchandise imports and the money value of its merchandise exports. The "balance of payments" is regarded as a broader measure of economic activities between nations because it includes merchandise and such "invisible" imports and exports as credit transactions and government payments abroad (for foreign aid or to support military forces, for example).
    The definitions are not as important, though, as the actual purpose behind them. Both "balance of trade" and "balance of payments" concepts attempt to fracture the process we know as "trade" so that the resulting fragments can be designated either "good" or "bad." In this way, "trade" is deemed to be "good" if it meets certain statistical criteria and "bad" if it does not. Such value judgments, moreover, are reached independently of the individuals who are doing the actual trading.
    The Mercantilists
    The first economists to develop this analysis of trade were the mercantilists, so it is certainly not new with today’s theoreticians. Thomas Mun, a leading mercantilist scholar of the seventeenth century, argued that England would prosper in foreign trade if only she would strive for a "favorable" balance:
    The ordinary means, therefore, to in­crease our wealth and treasure is by Foreign Trade wherein we must ever observe this rule; to sell more to strangers yearly than we consume of theirs in value. For suppose that when this Kingdom is plentifully served with Cloth, Lead, Tin, Iron, Fish and other native commodities, we doe yearly export the over-surplus to forraign Countreys to the value of twenty two hundred thousand pounds, by which means we are enabled beyond the Seas to buy and bring in forraign wares for our use and Consumptions, to the value of twenty hundred thousand pounds; By this order duly kept in our trading, we may rest assured that the Kingdom shall be enriched yearly two hundred thousand pounds, which must be brought to us in so much Treasure, because that part of stock which is not returned to us in wares must necessarily be brought home in treasure…2
    Mun and the mercantilists be­lieved that a nation must never buy from foreigners more than it sells to them. If such an "unfavorable" balance occurred, the nation had to pay the difference in gold, the internationally-accepted medium of payment. To prevent that, the gov­ernment was supposed to actively promote an excess of exports over imports. Mercantilists were so con­vinced that specie itself constituted the wealth of the nation that they closed their borders to trade and often waged war in order to protect and accumulate vast supplies of gold. That a nation should strive for a "favorable" balance of trade (more exports than imports) is the economic heritage of the sixteenth, seventeenth, and eighteenth cen­turies.
    Mercantilist reasoning did not die with the mercantilists, however. According to the U.S. Department of Commerce, imports surpassed exports for eight consecutive months through January 1977. This situation, disparagingly labeled a trade "deficit," is provoking concern among many orthodox econo­mists. Already, demands are increasing for restricting imports to redress the "imbalance." Japan is singled out for particular scorn, because she sold $5 billion more in goods to the U.S. than the U.S. sold to her in 1976. Each month that government statistics indicate an "unfavorable" balance seems to push America closer to a neo-mer­cantilist policy of protectionism and trade wars.
    Adam Smith and Bastiat
    It was Adam Smith who first at­tacked the notion that exports are good and imports are bad. He pos­tulated a "harmony of interests" in trade, by which both parties to an exchange benefit. With the excep­tion of obvious fraudulent prac­tices, which are minimal in number and a responsibility of the courts, there can be nothing "unfavorable" about voluntary trade from the point of view of the individuals do­ing the trading, otherwise those in­dividuals would not have engaged in it.
    This principle is readily visible when trade involves two parties within a country; it somehow becomes confused if an invisible political barrier separates the two. Introduce more than one currency and the principle becomes all but totally obscured in the welter of economic fallacy. Mercantilists of yesteryear and like-minded economists of today face an impossible dilemma posed by this question: Since each and every trade is "fa­vorable" to the individual traders, how is it possible that these trans­actions can be totalled up to pro­duce something "unfavorable"?
    Frederic Bastiat, the nineteenth-century French economist and phil­osopher who exploded myths with stunning clarity, once addressed himself to this very point. His anal­ysis remains to this day one of the best critiques of the "unfavorable balance" concept:
    M.T. despatched a ship from Le Havre to the United States, with a cargo of French goods, chiefly those known as specialties of Parisian fashion, totalling 200,000 francs. This was the amount declared at the customhouse. When the cargo arrived in New Orleans, it had to pay a shipping charge of ten per cent and a tariff of thirty per cent, which brought the total to 280,000 francs. It was sold at a profit of twenty per cent, or 40,000 francs, for a total price of 320,000 francs, which the consignee converted into cotton. This cotton had to pay ten per cent more, for transporta­tion, insurance, commissions, etc.; so that, when the cargo arrived at Le Havre, its cost amounted to 352,000 francs, and that was the figure entered into the accounts of the customhouse. Finally, M.T. again realized, on this return trip, twenty per cent profit, or 70,400 francs; in other words, the cotton sold for 422,400 francs.
    If M. Lestiboudois requires it, I shall send him some figures taken from the books of M.T. There he will see, in the credit column of the profit-and-loss account—that is to say, as profit—two entries, one for 40,000 francs and the other for 70,400 francs; and M.T. is fully satisfied that in this respect his ac­counting is not in error.
    And yet, what do the figures in the ac­count books of the customhouse tell M. Lestiboudois regarding this transac­tion? They tell him that France has ex­ported 200,000 francs, and that it has imported 352,000 francs; whence the honorable deputy concludes "that it has consumed and dissipated the proceeds of previous savings, that it has im­poverished and is on the way to ruining itself, that it has given away 152,000 francs of its capital to foreigners."
    Some time afterward, M.T. dis­patched another ship with a similar cargo, worth 200,000 francs, of products of our domestic industry. But the un­fortunate vessel sank while leaving the harbor, and there was nothing else for M.T. to do but to inscribe in his books two brief entries phrased thus:
    Meanwhile, the customhouse on its part was entering 200,000 francs into its export ledger; and as it will never have anything to enter into the opposite im­port ledger on this account, it follows that M. Lestiboudois and the Chamber will view this shipwreck as a clear net profit of 200,000 francs for France.
    There is still a further conclusion to be drawn from all this, namely, that, ac­cording to the theory of the balance of trade, France has a quite simple means of doubling her capital at any moment. It suffices merely to pass its products through the customhouse, and then throw them into the sea. In that case the exports will equal the amount of her capital; imports will be nonexistent and even impossible, and we shall gain all that the ocean has swallowed up.3
    In a parting shot, Bastiat again applies reductio ad absurdum logic to the argument. He declares:
    Assume, if it amuses you, that for­eigners flood our shores with all kinds of useful goods, without asking anything from us; even if our imports are infinite and our exports nothing, I defy you to prove to me that we should be the poorer for it.4
    A Two-Way Street
    It ought to be obvious that trade is a two-way street. In a free mar­ket, where trade is a voluntary, de­sired, and spontaneous feature of human action, there is a "perfect balance." Professor W.M. Curtiss demonstrates that trade between people of different nations is no dif­ferent in this respect from trade between people of the same nation:
    Suppose you sell a bushel of apples for two dollars. You get two dollars, which you would rather have than the apples; the buyer gets the apples, which he would rather have than the two dollars. A perfect balance!
    True enough, our exporters may sell goods to English buyers and get ster­ling exchange. They may spend this money in France or Germany rather than in England, so that the flow of goods is not directly between England and America. But the same might be true in the trade of apples for dollars. With your two dollars, you probably will buy something from a third party rather than from the man who bought your apples.5
    The mercantilists, we have noted, viewed the export of money and bul­lion as inherently evil. Exports were to be encouraged and imports dis­couraged by means of tariffs and quotas in order for money to be "kept in" the country. Similar cries are heard today. Many economists and government officials view with alarm any net outflow of money to foreigners.
    In the context of individuals engaged in free trade, such alarm is misplaced if directed at the market. Often a net outflow of funds is a symptom of the government’s own policy of inflation which erodes public confidence in the dollar. Professor Ludwig von Mises believed that in any case, this occurrence
    … is not the product of an unhappy concatenation of circumstances that be­falls a nation like an act of God. It is the result of the fact that the residents of the country concerned are intent upon reducing the amount of money held and upon buying goods instead.6
    Furthermore, Mises contended, it is not correct to assume that gov­ernment must take measures to prevent a total loss of the nation’s money by such an "unfavorable balance." Quoting from Professor Mises again:
    No government interference is needed to prevent the residents of New York from spending all their money in deal­ings with the other forty-nine states of the Union. As long as any American at­taches any weight to the keeping of cash, he will spontaneously take charge of the matter… But if no American were interested in keeping any cash holding, no government measure con­cerning foreign trade and the settlement of international payments could prevent an outflow of America’s total monetary stock.?
    Keynes was correct when he said that ideas, right or wrong, rule the world. The undue concern over the "balance of trade" and the "balance of payments" will quite probably produce wider restrictions on inter­national trade. If that occurs, our government’s policy-makers will be treading blindly in the footsteps of the defunct economists and aca­demic scribblers of mercantilist times.
    1John Maynard Keynes, The General Theory of Employment, Interest and Money (New York: Harcourt, Brace and World, 1964), p. 383.
    2"England‘s Treasure by Forraign Trade," 1664 by Thomas Mun in John R. McCulloch (ed.), Early English Tracts on Commerce (Nor­wich: Jarrold and Sons, Ltd., 1952), pp. 125-26.
    3Frederic Bastiat, Economic Sophisms (Irv­ington, New York: Foundation for Economic Education, 1968), pp. 53-54.
    4/bid., p. 55.
    5W.M. Curtiss, The Tariff Idea (Irvington, New York: Foundation for Economic Educa­tion, 1962), p. 36.
    6Ludwig von Mises, Human Action (Chicago: Henry Regnery Co., 1966), p. 452.


  22. May Xu:

    The Fallacy of Trade Balance by Frederic Bastiat

    The Balance of Trade

    The balance of trade is an article of faith.
    This is an example of the dauntless naïveté of following an absurd premise to its logical conclusion. M. Mauguin has discovered the secret of making even Messrs. Drably and Lebeuf laugh at the expense of the balance of trade. It is a great achievement, of which I cannot help being jealous.
    My second transaction had a very different result.
    Suppose that M. Mauguin had the power (and to a certain extent he has, by his votes) to substitute his calculations and desires for the calculations and desires of businessmen and to give, in his words, "a good commercial and industrial organization to the country, a good impetus to domestic industry." What would he do?
    For my part, I affirm that if someone were to say to the House of Commons: "The total value of what is exported from the country exceeds the total value of what is imported," it is then that they would feel threatened; and I doubt that a single speaker could be found who would dare to add: "The difference represents a profit."


  23. Hector Jose Serrano:

    Keep in mind though, that China can spend those US Dollars, elsewhere. For example buy Euros and then buy something from Germany. Buy US Debt, etc... The Dollars are not spent on the US Economy, if they buy US Securities, it is "LENDING the Dollars to USA", if it spends it on germany for example. Germany then yeah can spend some of those US Dollars with the USA, but it could buy more securities for example