Regressive Thinking about Trade

by Don Boudreaux on May 29, 2009

in Balance of Payments, Trade

Here’s a letter that I sent yesterday to the American Prospect:

Dear Editor:
.
You boast that your magazine is “the essential source for progressive ideas.”  And yet your contributors, including recently Dean Baker in the blog that you host, are forever lamenting the U.S. trade deficit (“China Knows It Will Take a Beating on Its Treasury Investments,” May 21).  Alas, these laments reveal no progress beyond the poor economic thinking and mercantilist policy proposals of the late middle ages.
.
For example, in 1381 Richard Leicester, worried about England importing more than it exports (and paying for these extra imports with money), could have been featured in your pages when he wrote that “Wherefore the remedy seems to me to be that each merchant bringing merchandise into England take out of the commodities of the land as much as his merchandise aforesaid shall amount to; and that none carry gold or silver beyond the sea, as it is ordained by statute.”*
.
True progress in understanding the nature of trade and the absurdity of fretting about the “balance of trade” – in understanding that wealth is access to goods and services and not gold, silver, or currency per se – did not begin until the late 17th century, especially with Nicholas Barbon.  Adam Smith capped this progress when in 1776 he noted that “Nothing, however, can be more absurd than this whole doctrine of the balance of trade.”**
.
Sincerely,

Donald J. Boudreaux

* Quoted in Jacob Viner, Studies in the Theory of International Trade (1937), p. 6.

** Adam Smith, An Inquiry Into the Nature and Causes of the Wealth of Nations (1776) Book IV, Chapter 3, paragraph 31.

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{ 46 comments }

Justin May 29, 2009 at 8:24 am

once again, you offer nothing less than total annhilation.

Daniel Kuehn May 29, 2009 at 8:45 am

Oooh – citations! Fancy.

Good points, all.

However, I think the modern concern is with consistent, large trade deficits that may result in unexpected, sharp, disruptive currency correction. After all, it's not like the American Prospect is yearning for equally huge, consistent surpluses to amass gold – right? You can at least admit that. So the comparison to mercantilists is a little clunky and misleading. But a good letter all the same. Sometimes I think Dean Baker needs to self-censor.

Brutus May 29, 2009 at 9:13 am

Daniel,

However, I think the modern concern is with consistent, large trade deficits that may result in unexpected, sharp, disruptive currency correction.

Well, those sort of currency corrections seem to be what you get with central banks in charge of the money supply.

Bret May 29, 2009 at 10:36 am

In a recent post, Russ Roberts is concerned that we are "living beyond our means".

Isn't foreign trade a necessary condition for living beyond our means? If the U.S. was a closed system, by definition we could only consume what we produce, and would therefore always be living within our means. Seems like the simple solution if living within our means is important.

mcwop May 29, 2009 at 10:47 am

Daniel, if Obama would stop deficit spending then our trade deficit would decline. If people would strop driving, then the trade deficit would decline. If the government did not add to the cost of transacting for a more fuel efficient car (sales tax, and limiting it to only hybrids), then maybe I would buy a new one, and lessen fuel consumption (of course I might buy a better value foreign car). There are solutions, if one thinks the trade deficit is a problem, but nobody is going to make any of these changes. Especially not the government.

Brutus May 29, 2009 at 10:48 am

Bret,

I'm not concerned with that.

Oh, and Autarky sucks.

Eric Hammer May 29, 2009 at 11:18 am

Bret,
You misunderstood the point of Russ's post. He was pointing out that we are spending much more than we make each year, and will have to pay back that debt at some point.

This is analogus to running up your credit card balance; the problem is not whether you are buying from the store down the street or paying your child 1,000$ to mow the lawn, the problem is that you are going to have to pay off that credit card debt at some point, and that is seriously going to cut into your ability to consume at a later point.

I_am_a_lead_pencil May 29, 2009 at 11:25 am

"If the U.S. was a closed system, by definition we could only consume what we produce, and would therefore always be living within our means."

Bret,
If our towns were "closed" or our families were "closed" we could only consume what we produce within them as well. Shrinking the division of labor ever more narrowly is the road to poverty.

Living beyond our means can be done in smaller closed systems as well. Example: Our town government could excessively borrow money.

Being pro-trade and anti-debt is an entirely compatible

Daniel Kuehn May 29, 2009 at 11:25 am

Eric Hammer -
Considering the fact that the Chinese and foreign oil producers are some of our major creditors, and that their lending is intimately tied to the trade deficit, Bret's point is absolutely relevant.

I don't think it's an accurate restatement of what Russ was trying to say – but then again, I don't think he was trying to restate what Russ said.

I wouldn't completely agree with Bret's conclusions for much the same reason that Brutus gave – "autarky sucks". But I still think it's relevant!

Daniel Kuehn May 29, 2009 at 11:28 am

I_am_a_lead_pencil -
Let's be careful not to put words in Russ's mouth. Being "anti-debt" makes about as little sense as being "anti-trade". The point is you don't want to borrow irresponsibly.

And since we're borrowing to buy a lot of what we buy abroad, I once again (as I said above) think that although Bret draws the wrong conclusions (I'd agree with you on that I_am_a_lead_pencil), his dual concern for the debt and the trade deficit makes perfect sense.

Bret May 29, 2009 at 12:07 pm

Let me be clear that I personally am not the least bit concerned with "living within our means" as a country nor am I the least bit interested in restricting trade of any sort.

I'm simply saying that if one was concerned with the U.S. living within its means (which I agree was not the main thrust of Russ's comments but he did express concern), the only real-world solution is to restrict trade. In theory? No. In practice? Yes.

Sam Grove May 29, 2009 at 12:27 pm

Daniel, since that other thread died, I thought I'd repost this again here:

>Sam -
RE: "So what caused the collapse in consumption?"

If you read the whole conversation, you'll note I cited the fall in asset values and co-occuring fall in confidence as the reason for the fall in consumption.

I wanted to prod you a little. You said the collapse in consumption caused the recession.

Might it not be more accurate to say that the collapse in consumption IS the recession?

With this edit:

Might it not be more accurate to say that the collapse in consumption (and the concurrent impact on production) IS the recession?

Daniel Kuehn May 29, 2009 at 12:33 pm

Sam Grove -
Yes, I think that's more or less accurate. Did I say anything that seemed to contradict that?

I think you see people think about contractions based on two metrics – GDP and unemployment. In terms of GDP, obviously the fall in consumption IS the recession. If you think about it in terms of a spike in unemployment, obviously the collapse in consumption is a cause.

I forgot how this back and forth got started, but I just want to make clear I don't feel "pressed" by that line of questioning at all – that's how I look at it too.

Brutus May 29, 2009 at 1:19 pm

Well, at least we are in agreement that autarky sucks. *This moment of togetherness brought to my me.* ;)

Sam Grove May 29, 2009 at 1:26 pm

When I think of "cause", I think it pertinent to go to the root. From there you can follow the sequence of events.

Government attempts to stimulate consumption is not a cure for the cause of recession.

S Andrews May 29, 2009 at 1:36 pm

Sam,

There is an interesting post on fiscal stimulus by Mario Rizzo on the ThinkMarkets blog.

Daniel Kuehn May 29, 2009 at 1:49 pm

Sam -
Fiscal stimulus is only advocated by economists when the fall in consumption itself BECOMES a cause even if it isn't the original causal mechanism. When there is a general weakening of the economy because of an adverse shock or something else, most people I've heard don't advocate fiscal stimulus.

People start talking about deficit spending once a recession has started, when falls in consumption lead to unemployment, which leads to lower wages – which together with unemployment leads to further falls in consumption – ie, a feedback loop. This is what fiscal policy is meant to help break.

So in that sense, the fall in consumption is the cause.

dg lesvic May 29, 2009 at 2:56 pm

Prof Boudreaux,

Great post, thrilling scholarship, magnificent.

K Ackermann May 29, 2009 at 3:08 pm

But isn't the fact that the trade deficit is being supported by selling debt an unsustainable process?

Also, credit expansion is like money expansion, and China's products either slowly get too expensive, or they peg their currency to the dollar and watch commodity prices rise… and have to make their products more expensive.

If I'm not way off base so far, then what?

Do we borrow or print more, and fuel the cycle, or do we reverse the process by either selling off assets or manufacturing and exporting, and hence restore balance of trade?

More like pendulum of trade.

Daniel Kuehn May 29, 2009 at 3:30 pm

K Ackermann -
If you believe that these markets correct themselves because that's what your teacher told you and that's what you believe, then you're wrong.

If you think there are institutional factors guaranteeing a perpetual and widening trade deficit, and if you think that violent adjustments may be more disruptive than the same market adjustment that occurs gradually (like I do) then I think you're on to something.

I'm not a trade expert, but I think people who assume these things will gradually and automatically correct themselves are being naive and wishful, if not dogmatic. You would think 1997-98 would have made them a little more circumspect, but I guess not.

Sam Grove May 29, 2009 at 3:33 pm

the fall in consumption itself BECOMES a cause even if it isn't the original causal mechanism

Yes, I'm familiar with the theory, but how does that deal with the original cause?

In the ABCT, the cause involves a misallocation of resources due to arbitrary credit expansion. If this is the case, then any stimulus will prop up continued misallocation, postponing the discovery of the bottom by taking the bottom lower.

SaulOhio May 29, 2009 at 3:34 pm

I've noticed that whenever you shoot down the arguments for a bad policy, "progressives" just find new arguments for them, that are just as bad. Thats their idea of progress.

Lets face it, they just don't like free trade, and want to control it if they can't abolish it. They will come up with any sophistry to justify it.

Daniel Kuehn May 29, 2009 at 3:40 pm

RE: "Yes, I'm familiar with the theory, but how does that deal with the original cause?"

That's not what stimulus is meant to address. The "original cause" here is the bubble. Reform and regulation of the sector, the failure of banks and households that made bad bets, and more circumspect monetary policy in the future are all how we're dealing with that original cause. But in that sense the "original cause" is a shock – the bubble won't burst again, so there's no cause left to address. It's like the oil shock in the 70s, or the rate hike in the 80s. You they didn't "fix the original cause" in the 80s by lowering the rates again. That would have completely defeated the purpose, it was a shock, and it just had to work itself out.

RE: " If this is the case, then any stimulus will prop up continued misallocation"

That's a big "if", Sam. You're not going to find very strong for ABCT out there. If you're fond of it, I'd stick around Cafe Hayek. But yes, it's certainly true that the stimulus is bound to cause some misallocation, just like monetary policy is bound to cause some inflation. The idea, though, is that the alternative is much worse – that whatever misallocation DOES occur will be far less damaging than the wage-price spiral that would have happened otherwise. And besides, in the case of some public goods – like education or infrastructure – there may be no misallocation at all because of previous underinvestment (obviously that's an unobserved counterfactual so we couldn't say).

Daniel Kuehn May 29, 2009 at 3:52 pm

Saul Ohio -
RE: "Lets face it, they just don't like free trade, and want to control it if they can't abolish it. They will come up with any sophistry to justify it."

Did someone on this thread oppose free trade? Did Dean Baker? Dean Baker says a lot of things, I don't think I've heard him come out against free trade, but maybe I'm wrong. Are you reading the same article as the rest of us?

The question is – is a persistent trade deficit something to worry about? Some of us have said "maybe – depending on how much you worry and what exactly it is that you're worried about". That's all.

Sam Grove May 29, 2009 at 4:47 pm

The "original cause" here is the bubble.

But the bubble is not the original cause, something caused the bubble. The bubble is a symptom, and not the one that is causing distress, it is the popping of the bubble that revealed that it was a bubble.

That's a big "if", Sam.

Supposing that the propping up of consumption will correct the reasons for the collapse is another big if.

The stimulus is based on the assumption that original conditions that brought about the bubble and the collapse have gone away with the collapse. Another "if".

You're not going to find very strong for ABCT out there.

Even with the missing word in it, this is an argument from authority/popularity which is not an argument at all.

The idea, though, is that the alternative is much worse -that whatever misallocation DOES occur will be far less damaging than the wage-price spiral that would have happened otherwise.

Another if, if it is the case that things were "spiraling" out of control. However, what if government actions where part of the spiral, what if uncertainty about what the politicos where going to do next made people hold back on risk taking.

etc., etc.

Part of the problem is that the government has formalized/rigidified certain aspects of economic functioning, that is, a variety of regulations have reduced the flexibility of many market actors.

This loss of flexibility makes correction more difficult, so rather than adjust, the economy bogs down.

The Albatross May 29, 2009 at 6:53 pm

1381–Cicero said the same thing in 63 BC over trade with Parthia–no wonder the two nations were always at war–where goods cannot pass troops will (to paraphrase an earlier post).

SaulOhio May 29, 2009 at 7:43 pm

The fact is that attempted stimulus by the government will, if carried through as much as is necessary to actually work, will always lead to a collapse of some kind. In "The Austrian Theory of the Trade Cycle and Other Essays", Von Mises explains why. Businessmen know that the part of their profits caused by inflation is an illusion. They will have to pay that much more for their next year's capital investment, so they factor that into their calculations. The inflation rate has to be greater than they expect in order for it to cause greater profits. So each year, the government has to ramp up inflation to a rate the businessmen don't expect. This way, if continued, leads to hyperinflation. (Von Mises himself didn't believe Zimbabwe was possible.) If hyperinflation is to be prevented, the government has to put a stop to its stimulus policies, undoing all the economic growth it stimulated.

Chuck May 29, 2009 at 8:47 pm

Where exactly does Dean Baker lament the trade deficit in the linked post?

The Albatross May 29, 2009 at 10:34 pm

(Von Mises himself didn't believe Zimbabwe was possible.)

Saul you had me until you said the above. I think Von Mises did see this in Weimer Germany. If not he saw it in the Hungarian inflation of the post-war period. Von Mises predicted it in the Theory of Money and Credit and then he saw it many times over. That being said, I think you comment quite good.

K Ackermann May 30, 2009 at 12:58 am

Stimulus is just a blip compared to the damage the massive credit expansion has caused.

It is going to cause massive pain as it gets unwound over the next few years.

The squeeze play is already starting. Quantitative easing is finally catching up to the bond market, triggering the steepest yield curve on record. Housing still has not bottomed, and here we go ready to raise interest rates again.

It's going to be wash, rinse, repeat with the banks and their 'assets'.

What is Bernanke going to do? How is he going to flatten the yield curve without raising expectations for inflation even further?

Can anyone believe the stock market went up today? Can anyone believe the stock market? I feel dirty even following it.

Maybe China can start a direct consumer finance program for us. Adjustible at US prime plus 7%. They can strike a deal with Treasury to garnish the wages of anyone defaulting.

Martin Brock May 30, 2009 at 7:27 am

You link Barker discussing Chinese monetary policy and China's accumulation of entitlement to U.S. tax revenue, and you never address a single point he makes.

Barker basically says that the resulting U.S. trade deficit with China is good for the U.S. in financial terms, because China expects to lose value in the process. So is he right or not? Yes or no? Why avoid the point by addressing issues he never raises?

Why does China buy entitlement to U.S. tax revenue expecting the U.S., via inflation, to return less valuable dollars, rather than buying U.S. real estate, U.S. corporate shares or other dollar denominated assets?

If the Chinese sell MP3 players to the U.S. today expecting to buy food from the U.S. in the future, why don't they buy midwestern farmland or shares of Archer Daniels Midland rather than entitlement to U.S. tax revenue that continually loses value to inflation?

If they buy entitlement to tax revenue because they can't buy the other assets for some reason, then how is the trade "free"?

You simply ignore these question.

Martin Brock May 30, 2009 at 7:51 am

Can anyone believe the stock market went up today?

Click through to the NY Times article that Baker discusses, and you find this statement.

"China … is changing laws to make it easier for Chinese companies to invest abroad the billions of dollars they take in each year by exporting to America."

SaulOhio May 30, 2009 at 8:00 am

"Saul you had me until you said the above. I think Von Mises did see this in Weimer Germany. If not he saw it in the Hungarian inflation of the post-war period. Von Mises predicted it in the Theory of Money and Credit and then he saw it many times over."

Was the inflation rate in Weimar Germany as bad as it is now in Zimbabwe? I know that in Germany, you needed a wheelbarrow full of marks to buy a pair of shoes, but in Zimbabwe, you need to be a trillionaire to buy a loaf of bread. I don't know how you compare the two, but Von Mises clearly stated that he thought an inflation rate of a million percent was theoretically possible, but would never happen. I have to wait till I get home today to look up the exact quote.

Zimbabwe's inflation rate was at over 200 million percent at one point.

Martin Brock May 30, 2009 at 12:21 pm

What is Bernanke going to do? How is he going to flatten the yield curve without raising expectations for inflation even further?

Bernanke only cares about common wages and consumer prices, and neither shows signs of upward pressure. He's willing, even eager, to stimulate inflation otherwise. If he reinflates house and share prices without raising the CPI-U too much, he's a hero.

K Ackermann May 30, 2009 at 3:05 pm

If he reinflates house and share prices without raising the CPI-U too much, he's a hero.

That's what we are all about now: focus on the short term, and make it through the next election. If we have to cook the books to get the bonus, well, we'll burn that bridge when we get to it.

Craig May 30, 2009 at 8:40 pm

"He was pointing out that we are spending much more than we make each year, and will have to pay back that debt at some point."

The debt is horrendous, Congress and the President must be blamed for that. The trade deficit didn't create it — it just funded it.

The Albatross May 30, 2009 at 9:22 pm

Saul,
I do not have time to look it up, but Weimar and the Hungarian inflation was just as bad. In the case of a billion and a trillion do not matter much. Once inflation passes a certain threshold then the numbers matter little. Hey, the Theory of Money and Credit was written in 1912, (like in his later writing) Von Mises didn’t think that things would go that nuts—he was wrong. He was also wrong about how a command and control economy would actually work—folks are smart and find their way around thing, despite massive inefficiencies. Look, I love the old bastard, but he forgot the human element—people will game the system and markets will work despite all the hardship thrown at them. MIses could be a little inflexible at times.
Respectfully,
The Albatross

Martin Brock May 30, 2009 at 10:03 pm

The trade deficit didn't create it — it just funded it.

Agreed. The problem is not that Chinese people want speculatively to exchange present goods for future goods or the means of producing future goods here. The problems are twofold.

First, their statesmen (and possibly ours as well) inhibit their purchase of real means of production here.

Second, our statesmen sell them entitlement to tax revenue instead.

On the other hand, our statesmen can't sell them entitlement to tax revenue unchecked, because we're nominally "democratic" and hopefully need not tolerate arbitrarily high tax rates. Therefore, our statesmen really only sell the Chinese entitlement to dollars that our statesmen can and do create at will.

The resulting inflation arguably costs the Chinese more than it costs us, but I'm reluctant to think in these collectivist, "us" vs. "them", terms. The inflation could cost me more than some Chinese individual and presumably does cost me more than Chinese statesmen constructing the rules of this game along with U.S. statesmen.

Daniel Kuehn May 31, 2009 at 9:21 am

Sam -
RE: "Supposing that the propping up of consumption will correct the reasons for the collapse is another big if."

Yes – I've never shied away from the fact that this is taking a chance. I've never been the one claiming to have gospel truth here. And I've always advocated a more middle of the road stimulus to avoid deflation, but not to fill the entire shortfall in GDP, precisely because I'm concerned about overcompensating.

RE: "The stimulus is based on the assumption that original conditions that brought about the bubble and the collapse have gone away with the collapse. Another "if"."

You might want to explain before you assert.

Sam Grove May 31, 2009 at 11:40 am

I'm basing that on your explanation of the reasons for the stimulus.

You explanation that the bubble itself was the cause rests on the assumption that the "shock" as an original cause is some transient blip on the economic screen that occurred as a result of some transient crossing of curves.

IOW, the bubble was the result of regular cycles that occur in an economy, and now that we have passed through that time, we are only suffering some sort of psychosocial trauma from that event and that a bit of therapy is all that is required to get the economy back on its feet.

Daniel Kuehn June 1, 2009 at 1:11 pm

Sam -
RE: "You explanation that the bubble itself was the cause rests on the assumption that the "shock" as an original cause is some transient blip on the economic screen that occurred as a result of some transient crossing of curves."

You have a really black and white view of the assumptions.

The cause is done and gone in the sense that the bubble is popped and it won't pop again.

It's not done and gone in the sense that the conditions that built the bubble are largely still there, and the feedback loops set in motion by the bursting bubble are still with us.

I think your attribution of the naive "the bubble is popped so everything is ok now" view to me is a little hard to follow… where do you get that?

Sam Grove June 1, 2009 at 8:55 pm

Damn, it didn't post.

You have a really gray view of the assumptions. Just thought I'd say that.

The bubble popping may have caused a shock to people who thought everything was fine, but the popping of the bubble is not the fundamental problem, not the fundamental issue.

You seem to be thinking that the conditions that have so far culminated in the bubble popping have been superseded as a problem by the psychological effects of the popping on consumer behavior.

This impact is a political problem, not the real economic problem.

Tell me, what is the fundamental economic problem facing U.S. residents?

Daniel Kuehn June 2, 2009 at 12:07 pm

Sam Grove -
RE: "You have a really gray view of the assumptions. Just thought I'd say that."

Right… isn't that always the best way to approach assumptions rather than hang too much on any single assumption?

RE: "The bubble popping may have caused a shock to people who thought everything was fine, but the popping of the bubble is not the fundamental problem, not the fundamental issue."

To reiterate, I agree. I have always agreed. Just because I think ABCT, which I know is what you're getting at, is weak doesn't mean I don't agree that the pop itself isn't eveything.

RE: "You seem to be thinking that the conditions that have so far culminated in the bubble popping have been superseded as a problem by the psychological effects of the popping on consumer behavior."

No, no no. It's not a psychological effect – nobody's saying it is – it's a real effect. People aren't buying less because they're scared (although I'm sure that has made a dent) – it's because their assets are worth a third of what they were before. And that REAL drop in consumption reduces job security, which in turn does it's part to reduce consumption of those who had low wages and no assets to begin with, but now also have a reason to cut back because their employers are potentially in trouble.

RE: "Tell me, what is the fundamental economic problem facing U.S. residents?"

Again?!?!?!?! You're really having a hard time internalizing what I'm saying, don't you?

Sam Grove June 2, 2009 at 1:46 pm

Well, you answered the last question just above…except that:

People aren't buying less because they're scared (although I'm sure that has made a dent) – it's because their assets are worth a third of what they were before.

Their assets aren't worth a third less, they just became aware that their assets had been erroneously valued 3X their real worth. They were never worth 3X.

Sam Grove June 2, 2009 at 1:59 pm

Correction: Their assets aren't worth a third of their previous valuation.

You're really having a hard time internalizing what I'm saying, don't you?

No, I'm just having a hard time communicating my point to you. If you really think that assets are worth a third less than they were before then I think I'm unable to express what I mean by "economic fundamentals".

The dollar valuation is meaningless except in a relative sense. Whatever REAL assets people have title to, the fundamental value of these assets is not known until they trade them for whatever they consume.

They may not be worth even a third less than before. Many of them may actually be worthless.

The valuation of these assets may have dropped to a third, but the real question is why they were valued at 3X the current valuation.

Austrian theory suggests that the reason these assets were overvalued is because credit expansion by the FED substituted speculative value for real economic growth.

Sam Grove June 2, 2009 at 3:45 pm

How does one distinguish between a bubble and real economic growth, especially if valuations are based on a floating reference?

How does one distinguish between the effects of the popping and appropriate responses to the discovery of inflated valuations?

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