What if….?

by Don Boudreaux on October 26, 2004

in Trade

Yesterday I attended an investment seminar. (Attending such seminars is among the benefits I enjoy by virtue of serving on the investment committee of the George Mason University Foundation Board.) I confess to knowing very little about investment and financial matters. So I learned a lot that I’m embarrassed publicly to admit (for fear of exposing how very little of such things I know).

Most of what I learned was very useful. But not all. In the latter category I place the assertion by the economist who told the audience that hurricanes do stimulate the economy “because of the payouts by the insurance companies.”

In this latter category I place also the same economist’s repeated assertion that “the twin deficits” are a catastrophe waiting to happen. I agree that Uncle Sam’s budget deficit is a cause for concern. But I disagree that the trade deficit – the current-account deficit – is a valid source of worry.

To his credit, this economist explained his reason for worrying about the current-account deficit. His reason is this: foreigners have been, and currently are, very willing to hold U.S. cash and financial assets. Suppose they stop? What then? The value of the dollar will plummet and the amount of investment in America will fall significantly. And that would be bad!

This analysis is valid. What’s not valid is the conclusion that the current-account deficit is a cause for concern.

Ask yourself: suppose that all of the investment that foreigners are now doing in America were instead done by Americans. The U.S. would have no current-account deficit; indeed, it likely would have a current-account surplus.

Would it then make sense for someone to say “but I worry about America’s current-account surplus. The reason I worry is that Americans might suddenly stop their current high level of investing in dollar-denominated assets. If they do stop, the value of the dollar will fall and the amount of investment in America will fall significantly. And that would be bad!”

Indeed this result would be bad for the American economy (assuming that foreigners don’t step in to make up for the lost investment). But no one worries that lots of investment in America by people holding U.S. passports is a looming problem because these Americans can, if they wish, suddenly cash in on their investments and stop further investment.

If we don’t worry about high levels of saving and investment in America by Americans, why should we worry about high levels of saving and investment in America by foreigners?

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