More Deficient Analysis and Reporting

by Don Boudreaux on December 17, 2004

in Trade

The writer who penned this report in today’s New York Times seems to try her best to scare readers into thinking that the U.S. trade deficit (more precisely, the current-account deficit) – now at $665 annually – is a gigantic load of debt that eventually must be paid.

The report cites this study by L. Josh Bivens of the Economic Policy Institute.  Here’s the opening line of Bivens’s study:

The United States is currently borrowing $665 billion annually from foreign lenders to finance the gap between payments to and receipts from the rest of the world, an amount equivalent to $5,500 per American household.

This claim is untrue.  The size of the U.S. current-account deficit is indeed $665 billion – but it is not all borrowed money.

It bears repeating again and again: a current-account deficit is not synonymous with debt.  Nor are all dollars that foreigners do not spend on U.S. goods and services loaned to Americans.  Many of these dollars are

- held as cash reserves
- used to purchase American real estate
- used to purchase shares in American corporations
- used to create, maintain, and expand foreign-owned firms located in the U.S.

Whenever foreigners use their dollars in any of the foregoing ways, (1) the U.S. current-account deficit increases, and (2) U.S. indebtedness is unaffected.

The only part of the current-account deficit that becomes debt is that part that is loaned to Americans – principally through the purchase by foreigners of dollar-denominated bonds (both government and private).

Suppose Mr. Toyota earns $1M by selling Camrys to Americans.  Further suppose that, during the current period, he spends $600K of this money buying American-made lumber, computer software, and Las Vegas vacations.

He does not spend the remaining $400K on U.S. goods and services during the current period.

This $400K that is not spent on U.S. goods and services makes the U.S. current-account deficit $400K larger than it would have been had Mr. Toyota spent the entire $1M on U.S.-made goods and services during the current period.

What does Mr. Toyota do with the $400K?  If he spends all of it buying U.S. Treasury Notes or bonds issued by General Electric, Inc., then this $400,000 part of the U.S. current-account deficit becomes debt.  Americans owe $400K (plus interest) to a Japanese citizen.

But if Mr. Toyota holds his $400K in cash, or buys commercial real-estate in Atlanta, or buys shares of Microsoft, or finances the start-up of his nephew’s sushi restaurant in Seattle, then these uses of the $400K – while contributing $400K to the U.S. current-account deficit – create not one cent of debt.  With these uses by Mr. Toyota of his dollars, no American becomes indebted to any foreigner.  There’s simply no debt in this picture.

Describing a current-account deficit as being synonymous with debt is a revelation of ignorance too deep to be excused.

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