Another Open Letter to Peter Morici

by Don Boudreaux on October 5, 2011

in Balance of Payments, Myths and Fallacies, Seen and Unseen, Trade

Prof. Peter Morici
Professor of Economics
University of Maryland

Dear Peter:

According to your essay today at, “Jobs creation remains weak, because the U.S. economy suffers from inadequate demand for what Americans can make” (“Our Economy Is Teetering On the Brink of Recession“).  Without here questioning the correctness of your mercantilist/Keynesian theory that employment is chiefly and straightforwardly a function of aggregate demand, I do question your identifying America’s trade deficit as one of the alleged causes of inadequate aggregate demand in the U.S.

You claim that the trade deficit “is a tax on domestic demand that erases the benefits of tax cuts and stimulus spending….  Simply, dollars sent abroad to purchase oil and consumer goods from China, that do not return to purchase U.S. exports, are lost purchasing power and cannot be spent on U.S. made goods and service.”

Simply, this claim is wrong.

As former Chief Economist at the U.S. International Trade Commission, you must know that another name for a trade (or, more accurately, a “current-account”) deficit is “capital-account surplus.”  Except for the tiny number of dollars that foreigners literally hoard, dollars in America’s capital-account surplus (aka “trade deficit”) return to America as demand for assets – that is, as investment demand in America.

Therefore, the dollars so invested – to create, or purchase equity in, U.S.-based firms; to lend money to the government and private parties; to buy real estate in America – do not disappear from the U.S. economy.  They return to the U.S. no less certainly than do dollars spent buying U.S. exports.  The only difference is that dollars that return as export demand are recorded on the current-account while dollars that return as investment demand are recorded on the capital-account.

You seem to be misled by a mere accounting convention into supposing that dollars that foreigners invest in the U.S., rather than spend on American exports, are somehow castrated of their capacity to serve as demand for American-made outputs.  But in fact these invested dollars are not only often used by foreigners to directly demand goods and services in America (as when, say, Ikea spends dollars building stores in New Jersey), but are spent on outputs also by Americans who receive them as loans or in exchange for assets sold to foreigners.

Donald J. Boudreaux
Professor of Economics
George Mason University
Fairfax, VA 22030


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