Coyote on the Trade Deficit

My apologies; the rest of the exchange went like this:

Conservative: Watch the US Dollar……everybody wants to get out of
US Bonds lol

Me: Let them take the losses for getting out of the bonds then. And hey, aren't you in favor of the lower dollar? The condition will eventually discourage importation of foreign goods and encourage the exportation of American goods. Do you understand any of this? How can you possibly argue both sides of the coin with a straight face unless you really do not understand this stuff?

Steven, you have a fine grasp on this topic as it is and I am just a rank amateur with a minor in Economics but if you are serious – which I am HOPING you are – here are my responses:

Because the USD is a widely accepted form of payment, yes, the foreign suppliers will take the dollar in exchange the goods. A lesser-traded currency would perhaps have to be exchanged at bank specializing in foreign exchange…the onus of the currency conversion being on the importer to pay the foreign supplier in the supplier’s favored currency. It really all depends on the terms of the transaction, though. Good catch using the word supplier instead of manufacturer, as supplier is more inclusive of the middlemen involved in importation/exportation!

The foreign holders of dollars – whether it is the ForEx bank or the suppliers themselves – do not necessarily have to invest in our debt. In fact, the CoyoteBlog entry linked to in this permalink details exactly what a foreigner may purchase instead of a U.S. debt instrument. If you are not directed to the CoyoteBlog post in question then it is, in turn, provided by an additional link in that linked to entry (does this even make sense?).

Capital controls are NEVER a good thing. We would shoot ourselves in the foot if we ever implemented them. At a micro level, people, businesses, and/or entities trade with one another to make themselves better off than before. I know of no one who trade with others in order to make themselves worse off than before. Assuming that millions of transactions occur on a daily basis across political boundaries (the definition of international trade) then everyone is increasing their well being each every transaction, right? Even if they were not, on FREEDOM grounds, how would the government restricting our choices be a good thing? The government is still “We the people”, right? Unfortunately, maybe not! How many people do you know, honestly, that refer to the Fourth of July as such but the thought never occurs to them to call it what it is: Independence Day?

Yes, the dollars will have to be recycled back to America unless, of course, the foreigner opts for the “under the mattress” option…which is just plain foolish and doesn’t really happen. It happens both directly – by purchasing American goods – or indirectly by purchasing USD dominated assets OR by purchasing another foreigner’s stuff who is willing to accept the USD as a form of payment. Eventually that USD has to be repatriated unless the mattress option is being foolishly used.

As for the foreigner buying land or other non standard financial instruments falling into the PP&E camp, it seems more disconcerting that a foreigner would by PP&E until one realizes that if the foreigner doesn’t reside in the United States, it might even be a better proposition…depending on your viewpoint. Warning, this is going to be a tangent!

I happen to view the purchase of US debt by an American citizen as an unwise choice. Milton Friedman laid it out for me in the book “Money Mischief” when he talked about how government taxes her citizens for the privilege of loaning the beast money to finance its vote-buying schemes [Dr. Friedman did not put it that way, of course] and how the purchasing power of the payments on such debt instruments erode with each printing of a new dollar [only not until the government got to spend the newly printed dollar at its original value before us dupes noticed what happened]. My view was further cemented by Ron Muhlenkamp, who articulately and simply, in his book “Harvesting Profits…” described why debt is not a winner. Keep in mind that even the government sets rates on its bonds based on the current rates in the secondary market for government and corporate bonds of various maturities. Muhlenkamp argues that businesses have a, more or less, adversarial relationship with people who lend them money and will only meet the terms of the loan. Contrast this with a business’s responsibilities to its shareholders and you see why, over the long haul, having equity is superior to providing loans to others. So, if an American owns a debt instrument, I am not in favor of it. But if a foreigner owns the debt instrument, I’m thanking him or her for the loan and allowing us to expand our businesses and our growth with an ‘easier’ loan.

On the other hand, if a foreigner buys land and does not reside here then s/he doesn’t reap the benefit other than the rent collected. But a purchase of PP&E will most certainly lead to some sort of production occurring in America – production that will be performed with, presumably, American labor. The profits of such a situation are retained and maintained by the foreigner but “So What?” I say. You’re a bright guy and I am willing to wager that none of this is new to you and you were just egging me on. In the event you were serious, though, I hope my rantings were helpful.

There is a sense in which the trade deficit represents the spending of Americans as a group. Alarmists want to paint the trade deficit as spending more than we earn, and that's only accurate in a limited sense. For the sake of argument, let's presume that it is not completely artificial to draw a box around every US citizen and treat us all as one economic unit.

If you do that, then the trade deficit does in fact represent the spending of that unit in excess of what it earns outside (at a job say, if we are treating it like a person). But in that analogy, it doesn't consider what the person is earning on investments. If what we're earning on investments is much greater than the difference between job income and spending, then that doesn't represent real deficit spending. Similar for trade. If the wealth we are creating via internal transactions is far greater than the trade deficit, then the trade deficit doesn't represent any kind of excess spending. If our wealth creation isn't keeping up with the trade deficit, then we are in a sense letting some of our wealth slip away. The fact that wealth is not zero sum, doesn't mean that there is some infinite supply just waiting for people to think "Hm, I need some more wealth now, let's go down to the wealth well". Wealth gets created by people creatively solving problems or doing work that people need done, and the economy has only so much capacity for wealth creation, and much of that capacity is sucked up by inefficient government regulation or redistribution on the social dem side, or alternately risk-avoidance and wealth-protective behavior on the laissez-faire side (Note: I wouldn't be posting here if I didn't think that the balance point for minimizing those inefficiencies was more likely to be in the direction of laissez-faire, but I think it's fantastical nonsense to presume without hard evidence that the second half of these inefficiencies don't exist.)

Now, Don and Coyote, etc. almost certainly would say that since every single transaction that creates the trade deficit is freely entered, we (the hypothetical borg of all americans) must be receiving fair value for the money we have let slip and thus we can't possibly be letting wealth slip away, we have those goods and services. That's a beautiful argument in the realm of economistan, but in the real world, I know a lot of people who choose too much consumption irrationally and regret it. It's certainly *possible* that this is happening to americans as a class.

It's crystal clear that putting up tariffs or regulating who can invest in US equity or buy US government and corporate debt is not going to solve the problem, if there is one, and will merely put up a costly barrier to economic growth.

But claiming that there can't possibly be a problem is foolish. The trade deficit may well be an indicator that Americans as a whole are overspending, and an indicator that much of the growth in the economy is being financed by benefactors in Asia who need not continue to do so, and when they stop, the dollar will drop, things will get more expensive and we may end up in a recession. It looks like this is already starting to happen.

It's not nonsense to see the trade deficit as a potential problem. What's nonsense is assuming that any trade deficit, no matter the size or the underlying growth of the domestic economy, means there is a problem. What's nonsense is thinking that protectionism can do *anything* about the actual problem of which a too large trade deficit is a symptom.

Protectionist policies could get rid of the trade deficit, but they would merely push the expression of the problem into other more obvious (and more painful) areas. The countries which currently hold debt and equity in the US may well decide to pull much of it out and do that for us, but as you say, it's in their interest not to do this swiftly. They are much more likely to merely stop financing additional deficits this way (which would make everything happen in a nice orderly manner) than to sell everything off and watch their own net worth plummet.

So I agree with your recommendation, I just think you go a bit too far in characterizing the trade deficit as essentially meaningless. It's a good indicator that much of our current economic growth is basically being financed by the Chinese. It's great while it lasts, but as the possibilities for investment in china get better, they get more and more likely to stop propping up the dollar.

Steven,

If you have any sense of history, like way back to the mid-1980s, you'll see that all of the anti-China trade arguments are repackaged anti-Japan arguments. Example 1: "Trade will ruin our manufacturing base and we'll have no economy." In actuality, our economy continues to grow strenuously year after year even as some domestic industries have faced stiff competition or extinction, i.e cars and TVs. And guess what? The cars and TVs are much better per dollar than 20 years ago in just about any way you care to account. Example 2: "They'll use the $ to buy up all our real estate or our great companies." Yeah, Japan did that too and took it in the shorts.

One long-term concern that I am sympathetic to is the specter of sinofascism. With over 1 billion people, if they got belligerent, the world would be tense place. Again though, look to Japan for a model. We dropped nukes on them just 60 years ago, and they have been in love with United States culture for a quarter century. Trade brought our cultures closer together after rebuilding was done. The same is happening with China, with a burgeoning "middle class" that loves all the trappings of western life. When you start looking at all the small to medium sized US companies that get products to market quickly by outsourcing manufacturing to Chinese companies, you can't help but recognize the strong economic ties our country has formed with China and the strong personal ties that make each of those company to company relationships work. If sinofascism is indeed a potential threat, we need more trade, not less.

Warren Buffett thinks the trade deficit quite a problem. Is he a bloviating buffoon too?