Imbalanced Thinking

by Don Boudreaux on October 10, 2009

in Balance of Payments, Myths and Fallacies, Trade

Here’s a letter that I sent yesterday to the San Francisco Examiner:

You mistakenly describe the U.S. trade deficit as an “imbalance” (“US trade deficit narrows unexpectedly in August; exports up, imports fall on lower oil demand,” Oct. 9).

Americans buy $100 worth of goods from foreigners; foreigners buy $70 worth of goods from Americans.  Foreigners either hold the remaining $30 or invest it in dollar-denominated assets.  Where’s the imbalance?

Would the U.S. economy be better off if foreigners spent the entire $100 buying American goods and services – and, hence, if foreigners refused to save and invest here?  If so, is the key to even greater American prosperity for Americans each to rush to the mall every payday and spend every cent of their paychecks?  If you see that prosperity would be compromised if dollar-earners holding U.S.-issued passports were so profligate, why do you suggest that prosperity would be promoted if dollar-earners holding non-U.S.-issued passports were equally profligate?

Sincerely,
Donald J. Boudreaux

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  • PerKurowski
    The $70 are for merchandise and regular services and the $30 are for safe-haven parking services… and so from this perspective your current account is balanced…. Except you run the risk of a lot of returns… but they might at that time settle for other US assets too... and so you might look at it as a prepaid giftcard to themselves... cheers
  • PerKurowski
    The 30 are not really held in dollars, they are held in what for the time being is considered as the parking permits for a safe-haven. One day the world might wake up and feel that the current safe-haven is becoming dangerously overcrowded and so the value of those parking permits will go down. Why do you insist on putting the blame on the US as it must be clear that others have not come up with any solutions either to the current imbalances?

    I as a Venezuelan know what living an oil-curse means. The Americans have yet to understand they are living a safe-haven curse.
  • Curious
    If the $30 are not dollars, are the $70 dollars and why?
  • muirgeo
    In my view … it is impossible to understand this crisis without reference to the global imbalances in trade and capital flows that began in the latter half of the 1990s. --Ben S. Bernan
  • Seekingexports
    If your are curious then why not sell all your U.S. dollars and buy yuan, then try and be a profligate consumer?
  • Curious
    Can you state a reason why is it possible to be a profligate consumer with $1, but not with 7 yuan, since they both purchase exactly the same amount of goods and services?
  • Curious
    Yes. Another way to look at the $100 transaction: The Fed changes the name of the owner of $100 in their computer from Johnson to Chang. That's it!
  • Seekingexports
    China needs to allow its citizens to become profligate consumers by allowing the value of yuan to float and establish an international value. This is not certainly a discrete action to free their citizens for profligate spending but along with lowering trade barriers and enforcing trade commitments, such as intellectual property rights proptection, great possibilities may occur (hopefully very soon).
  • Curious
    What is the difference between China keeping its currency pegged to the USD and China becoming dollarized (abolishing yuan and using USD instead). I don't see any difference.

    If there is no difference, why not call for let's say California to establish their own currency and let it float, because they have a trade surplus with the rest of the US?
  • The reason it IS an imbalance is because foreigners are not investing their trade surplus ($30 in your example) in productive, private-sector bonds but rather in unproductive, public-sector bonds. On the one hand, the increased demand for these treasuries pushes down interest rates, thereby discouraging domestic saving and encouraging domestic speculation, malinvestment, and consumer over-indebtedness. Malinvesting entrepreneurs (who are fooled by artificially low interest rates) and over-indebted consumers (who are fooled by both the low interest rates and their artificially inflated asset prices) then purchase more foreign producer and consumer goods and this leads to continued trade deficits which prolong the cycle. On the other hand, the government uses the funds from these foreign loans to wage wars and pay for the welfare state, both of which, you would surely agree, are detrimental to economic growth. Now that the US government has begun inflating its way out of the debt burden, our foreign creditors will soon start selling treasuries, which will result in a sharp rise in interest rates, wide-spread corporate and consumer bankruptcies, increased savings, and reduced consumption. This will expose and correct the imbalances in our system. Now, if the foreign countries were instead simply taking their surplus and buying private-sector bonds, stocks, land, or other assets, then I would whole-heartedly agree with your argument!
  • LowcountryJoe
    >>The reason it IS an imbalance is because foreigners are not investing their trade surplus ($30 in your example) in productive, private-sector bonds but rather in unproductive, public-sector bonds.<<

    Surely not all 100% of the USDs come back and buy government bonds exclusively. And let's call this what it is, even if that were the case: this is foreign governments shunning higher-yielding debt instruments [and property and equity securities] for other purposes (e.g. manipulating the exchange rate..if you believe in that sort of thing). Since the problem reeally lies with government over-spending creating the need to float new federal government bond issues, it's really not fair to criticize trade for this.

    >>On the one hand, the increased demand for these treasuries pushes down interest rates, thereby discouraging domestic saving and encouraging domestic speculation, malinvestment, and consumer over-indebtedness.<<

    There are much more insidious things to blame for the lack of domestic 'savings' in our country. First of all, investments that rely on appreciatiation (equity building) is a way to forego consumption now for the ability to consume in the future. So, not 'saving' is truly a misnomer.

    With that out of the way, tell me why 'savings' is such a good idea. With savings vehicles taxed at the income tax rate, many people with money to 'save' are rewarded with an excessive tax for the 'luxury' for doing so. And after taxes, inflation eats away at what's left over and pretty much makes 'savings' a net wash -- certainly a less attractive alternative to equity securities with their lower tax rates and the inherent ability to keep up with inflation [don't get me started about just how tax advantageous it is to purchase real estate].

    Now, with those on the table and with Social Security [and its 12.6% compusory savings rate on income] forced upon the working population, are we not already 'saving' if we believe that that f___ing system really does work?


    >>Malinvesting entrepreneurs (who are fooled by artificially low interest rates) and over-indebted consumers (who are fooled by both the low interest rates and their artificially inflated asset prices) then purchase more foreign producer and consumer goods and this leads to continued trade deficits which prolong the cycle.<<

    Malinvesting entrepreneurs and over-indebted consumers are just responding rationally to the choices that they face because the government has set out the carrots and sticks in such a way that leads to this outcome. Maybe this is not what the planners had intended but everything about the rules of the game should be make the outcome recognizable.

    >>Now that the US government has begun inflating its way out of the debt burden, our foreign creditors will soon start selling treasuries, which will result in a sharp rise in interest rates, wide-spread corporate and consumer bankruptcies, increased savings, and reduced consumption. This will expose and correct the imbalances in our system.<<

    I'm actually going to welcome the day this happens. It will be painful. It will suck. But, in the end, it will be neccessary if there's ever any hope to remove the planners and see some change we can believe in. Could it lead to more tyranny? Yep. But either way, tyranny would be coming; best to take a shot at the immediate pain direction and watch the 50/50 chance play out rather than the 100% chance that everything become nationalized. There will be blood!

    >>Now, if the foreign countries were instead simply taking their surplus and buying private-sector bonds, stocks, land, or other assets, then I would whole-heartedly agree with your argument!<<

    Are you in favor of demanding that no more federal debt be created to cover budget shortfalls -- to include not using Social Security taxes to pay for general spending...[oops, even that trick has been taken way]?
  • <<Since the problem reeally lies with government over-spending creating the need to float new federal government bond issues, it's really not fair to criticize trade for this.>>

    I completely agree with you on this!

    <<With that out of the way, tell me why 'savings' is such a good idea. With savings vehicles taxed at the income tax rate, many people with money to 'save' are rewarded with an excessive tax for the 'luxury' for doing so.>>

    I agree with you that a highly inflationary environment, such as we've had since at least the 1960's, encourages investment in relatively inflation-protected assets such as stocks and real estate. There are, of course, also tax issues regarding capital gains vs. income. I think we agree that both high inflation and high taxes are bad.

    <<Now, with those on the table and with Social Security [and its 12.6% compusory savings rate on income] forced upon the working population, are we not already 'saving' if we believe that that f___ing system really does work?>>

    Actually, no. That's not savings because it's not voluntary and it's not being multiplied and lent out to productive entrepreneurs but rather redistributed. And no, we don't believe that that system works!

    <<Malinvesting entrepreneurs and over-indebted consumers are just responding rationally to the choices that they face because the government has set out the carrots and sticks in such a way that leads to this outcome.>>

    Again, I agree that people in general were acting "rationally" but misled, and continue to be misled, by false signals sent to them by government distortions of the market.

    <>

    The sooner the better, because the problem is getting progressively more serious. But I sincerely hope there is no blood.

    <<Are you in favor of demanding that no more federal debt be created to cover budget shortfalls[...]>>

    Yes! But we should avoid the budget shortfalls in the first place by cutting spending and then, once the debt is eliminated or at least more manageable, cutting taxes.

    Thanks for all your insights.
  • vikingvista
    Your analysis is mostly correct, but your blame is misplaced. What you describe is clearly a US government political problem, and part of the same problem that also involves Americans buying government debt, and Americans being taxed. No trade policy can fix that problem, so no blame can reasonably be placed upon trade.

    Don is correct that Americans buying foreign goods constrains foreigners ultimately to buying American goods, assets, services, or debt. It is the corruption of the US political process that makes government debt a more attractive purchase to both foreigners and Americans.
  • @vikingvista: Thanks for your reply. I certainly agree with you that the US government deserves the blame for this problem and that no trade policy would fix it. My only point, with which I guess you agree, is that our treasury-financed trade deficit IS in fact indicative of a serious imbalance, which will one day be corrected. Of course, the Chinese government, for example, would not be able to buy US treasuries if our government had no appetite for debt and preferred balanced budgets! Can you please explain what you mean by the following: "It is the corruption of the US political process that makes government debt a more attractive purchase to both foreigners and Americans." Thanks.
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