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 FoxNews.com, “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.

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

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{ 99 comments }

Invisible Backhand October 5, 2011 at 3:36 pm

I’m a little confused about money that leaves the capital account to purchase assets versus money that is just expenses. Land and buildings are certainly assets, but I doubt SG&A expenses are.

Chris O'Leary October 5, 2011 at 4:04 pm

I’m amazed that. given the complexity of the economy, he knows exactly what’s going on.

Very impressive.

muirgeo October 5, 2011 at 4:18 pm

OK so Professor Morici says our trade policy is bad for our economy yet Professor Boudreaux says it is good for our eocnomy. Hmmm how to decide… I think I’ll go outside and actually take a look at how the economy is doing… be right back… just gonna step outside and check on the economy……..
……………
……………
……………

OK … I’m back… ewe…wow … it SUCKS out there. 37% poverty rate for young families. I think I’ll go with what Professor Morici says as fitting best with reality.

Ken October 5, 2011 at 4:20 pm

muirgeo,

Don’t forget to put the word “relative” in front of the word “poverty” when citing “poverty” statistics in the US. Absolute poverty has been erased from the American landscape.

Regards,
Ken

Invisible Backhand October 5, 2011 at 7:19 pm

Don’t give up Ken, Wall Street is working on bringing it back.

Rugby1 October 5, 2011 at 7:30 pm

Actually many politicians are working on keeping people in relative poverty as perpetuating a cycle of poverty while pretending to be the champion of the people is the ultimate in vote snatching.

Rugby1 October 5, 2011 at 7:31 pm

I need an edit button.

Should be two distince sentences.

Actually many politicians are working on keeping people in relative poverty. As perpetuating a cycle of poverty while pretending to be the champion of the people is the ultimate in vote snatching.

Invisible Backhand October 5, 2011 at 8:22 pm

Yes, almost all Republicans and most Democrats, but they are just puppets. Wall Street holds the strings.

GhengisKhak October 5, 2011 at 9:48 pm

“Yes, almost all Republicans and most Democrats, but they are just puppets. Wall Street holds the strings.”

I know just how to solve this. To the degree possible, let’s abdicate all decision making and control to the federal government. Historically, centralized power has always been controlled by the rich and powerful that you are railing against, often toward nefarious ends. But this time we have the Good Guys at the helm, so it’ll be all good.

Dan J October 7, 2011 at 1:56 am

This time it will be different. As the messiah as said, ” we are who we have been waiting for.” kinda creepy. I think Obama ‘likes’ his own Facebook postings often under his alias of ‘F. Engels’.

Ken October 5, 2011 at 7:57 pm

IB,

As Rugby1 said, you’re comment needs revision: Wall Street and politicians are working to bring it back.

Regards,
Ken

Rugby1 October 5, 2011 at 8:55 pm

@ IB

How would Wall Street “hold the strings” if there were no strings to hold. By your very phrase you acknowledge that the real problem is government. If Wall Street did not have the capacity to “hold the strings” because let’s say….. government was reduced down to its enumerated powers then bam, look at that crony capitalism is reduced, competition comes to the forefront, and small businesses can thrive because they are not forced to protect against behemoths insulated from their poor decision making.

Craig October 5, 2011 at 7:58 pm

Congratulations, Muirgeo. You have done what few have been able to accomplish before: establish trade policy as the only determinant of the nation’s economic well-being.

Well done!

Rob October 5, 2011 at 8:20 pm

Is it too late to have him considered for a Nobel?

John October 5, 2011 at 4:20 pm

well Dan, you admit that Observer has it right: the returning money is use “to lend money to the government.” Thus what gov’t does with the money is crucial to understanding whether a current account deficit is good or bad.

At this point your arguments become surreal. I argue that gov’t has been spending badly. It is just giving the $$$ to people who are buying even more from China–that the dollars are not flowing into investment in the US. In fact, as exports have risen investment in the US has declined (the giant sucking sound of jobs going overseas). Whereas you ordinarily argue that Gov’t is bad, you now argue, that Gov’t is good, that it is investing and spending these returning dollars wisely. You cannot have it both ways.

There is a second inconsistency in your argument. You want to shrink gov’t. However, to grow trade, as you seem to support, Gov’t must borrow more and more, for the Chinese, etc., don’t want to invest in the U.S. (this would be contrary to their invest in jobs in China policy). In sum, for once in your life, be honest. We do not have trade. We have politics being played between the U.S. and China, each gov’g using the other for its own purposes. It has been horrible for the American worker and family and only looks to get worse.

kyle8 October 5, 2011 at 5:38 pm

However, that is not an argument against free trade, that is an argument against a free spending congress.

Darren October 5, 2011 at 6:54 pm

Yes, but one must consider the practical consequences of a policy, what actually happens not what theoretically *should* happen.

John Dewey October 5, 2011 at 5:44 pm

John: “what gov’t does with the money is crucial to understanding whether a current account deficit is good or bad.”

Federal government spending is not at all dependent on Chinese purchases of U.S. Treasuries. If China didn’t buy the debt, someone else would. Interest rates would have to increase. So, what Chinese purchases of U.S. debt actually does is keep interest rates lower.

John: “the Chinese, etc., don’t want to invest in the U.S.”

That is incorrect. Chinese firms have been investing in the U.S. The Chinese would have invested much more had they not been consistently delayed by U.S. elected officials’ concerns about national security.

Don Boudreaux October 5, 2011 at 7:17 pm

Yep. Exactly correct.

Observer October 5, 2011 at 8:38 pm

Dan, to ask the obvious, did you ever ask, Why do the Chinese only want to invest in companies that have national security risks?

Did you ever make room for the possibility that stealing secrets is a exception to China’s general rule against investing in the US if it keeps jobs here?

Did you ever make room for the possibility that the “attempted” investment is a cover, intended to and successfully diverting attention from what is really going on: It may let China and the Fed gov’t off the hook as to why the Chinese are not investing.

IOW the game is being played with a level of sophistication far beyond your understanding.

On a related point, on Monday Joseph E. Stiglitz wrote:

But the economy was very sick before the crisis; the housing bubble merely papered over its weaknesses. Without bubble-supported consumption, there would have been a massive shortfall in aggregate demand.

http://www.project-syndicate.org/commentary/stiglitz143/English#comments

Now, according to your theories, he was wrong and those years were the best of times–Bush was in office and regulation and taxes were down, taxes being at all time lows, and the current account was at an all time high, which according to you should have been a great thing.

In sum, your rules did not produce the reality you claimed they would. Here is your Greenspan moment—time to fess up and admit that something is wrong with your theories

Methinks1776 October 5, 2011 at 9:09 pm

IOW the game is being played with a level of sophistication far beyond your understanding.

Yep. To fully understand what’s going on, you need a tin foil hat and a plastic sword.

vidyohs October 5, 2011 at 9:26 pm

With the Clintons in the WhiteHouse the Chinese never had to steal a military secret or want for technology to make bigger and better weapons with state of the art guidance systems…..hell, Ole Billy just up and sold it to them. (Because the Chinese promised, promised I tell you, that they would never use them in developing military tech. Bwa ha ha ha ha ha!)

Gotta love them commies (domestic and foreign).

odinbearded October 6, 2011 at 9:30 am

Regulation was down during the Bush years? Taxes were at “all time lows?”

Huh. Are you sure you’re talking about the U.S. here?

Dave October 8, 2011 at 11:45 am

The Code of Federal Regulations grew during the Bush Administration, as did the budgets for regulatory agencies.

vidyohs October 5, 2011 at 4:30 pm

So many people seem reluctant to say it but the problem in the USA economy, our markets, our business, our governmental regulatory agencies, is the socialism that was allowed in as official policy with FDR and is continued to this day.

Jobs creation in this nation is reluctantly slow for one simple reason, a socialist president and socialist cronies.

No one knows where these idiots are going to take us before we can get rid of them (if it isn’t already too late to do so); but from all evidence so far ,they want to take us into a series of Mao style business, market, and economic idiocies.

So what the hell is a business man to do? He sees what seems to be a good opportunity, but does he step out and invest money in a risk considering that the Obama crowd seems determined to crash our economy completely? I sure as hell would not, why would I be surprised that no one else really wants to?

Everything real in the economy, real in the market, real in business, real in experience, real in history, and real in character has been trumped by skin color. I’d run, but there isn’t anyplace to run to where real still counts.

Observer October 5, 2011 at 4:48 pm

vidyohs

give it up, seriously

there are no good businesses in which to invest because there is no demand. 99.5% our our people do not have the money to pay for much of anything. this is especially true if they have children to send to college, given how states are cutting back on college funding and given the cost of health care (double the cost of the rest of the world)

the solution to our problems is to increase the leverage of our lowest income workers so that they can raise their incomes and spend.

Ken October 5, 2011 at 5:28 pm

Observer,

There is enormous demand for ALL quality craftsmen in pretty much any industry in the private sector, particularly high skilled craftsmen like engineers.

The flip side of this is there is also a HUGE demand for taxes by politicians. Since it’s very unclear how much of people’s wealth politicians are going to take and how hard the government is going to make it to satisfy that private demand, why bother to produce more than is necessary, particularly if “excess” or “idle” wealth is to simply be taken by the government?

Regards,
Ken

Invisible Backhand October 5, 2011 at 7:28 pm

These engineers that there is “enormous demand” for have a 6.2% unemployment rate.

ftp://ftp.bls.gov/pub/special.requests/lf/aat25.txt

Ken October 5, 2011 at 8:05 pm

IB,

Yes. And 6.2 < 9.1, showing that there is enormous demand for engineers relative to the average worker.

I, also, notice you selectively ignore the second half of my comment, which shows while even in the face of enormous demand for ALL quality craftsmen. Namely that the demand for ever more taxes by politicians largely increases economic uncertainty, keeping private employers who have an enormous demand for quality workers to act on that demand.

That the unemployment rate for the average worker is 50% hire than the unemployment rate for engineers and that the economic uncertainty created by greedy politicians ready to gobble up all gains made by the private sector counteracting that demand, is ample evidence of the enormous demand for engineers.

Thank you for finding evidence supporting my original comment.

Regards,
Ken

Invisible Backhand October 5, 2011 at 8:17 pm

Backpedal

Ken October 5, 2011 at 8:49 pm

IB,

“Backpedal”?!

Do you even know how to read? Take a minute to read the entire comment I left for Observer. I guess after all my interactions with you in the past, I shouldn’t be so shocked at your gross incompetence or gross dishonesty. But somehow I still am.

Well you are a standard representative of the democratic party and the left in general.

Regards,
Ken

Invisible Backhand October 5, 2011 at 9:11 pm

RegardsKen, you are unaware that you are nuts. You can’t make up new meanings for words inside your head and expect the rest of the world to go along with you.

http://www.reddit.com/r/CafeHayek/comments/l2dz8/these_are_the_kind_of_idiots_i_deal_with_2/

Ken October 5, 2011 at 9:34 pm

IB,

Since you’re too stupid to read it, here’s the entirety of the first comment I left:

There is enormous demand for ALL quality craftsmen in pretty much any industry in the private sector, particularly high skilled craftsmen like engineers.

The flip side of this is there is also a HUGE demand for taxes by politicians. Since it’s very unclear how much of people’s wealth politicians are going to take and how hard the government is going to make it to satisfy that private demand, why bother to produce more than is necessary, particularly if “excess” or “idle” wealth is to simply be taken by the government?

Was that second paragraph too ambiguous for you? Do you not understand that the demand for workers, work, and goods are being hindered by government intervention?

I really am nuts, though, to think you would be honest or intelligent.

Regards,
Ken

Invisible Backhand October 6, 2011 at 7:48 pm

These engineers that there is “enormous demand” for have a 6.2% unemployment rate.

ftp://ftp.bls.gov/pub/special.requests/lf/aat25.txt

Ken October 6, 2011 at 11:26 pm

IB,

I see you’re still unable to understand what I’ve clearly written. I expected nothing less.

Regards,
Ken

kyle8 October 5, 2011 at 5:44 pm

That is idiotic. All of the problems you cited are exacerbated by government involvement. And your solution is also stymied by government. If we just had a moratorium on all new regulations and eliminate the capital gains tax, there would be enormous hiring and wage and asset growth.

As long as you have a government that threatens businesses, punishes achievement, offers handouts to the unproductive, caters to union thugs, threatens high tariffs, increases regulations at an astronomic rate, devalues the currency, and crowds out investment with it’s colossal debt, then you will get more of what we have seen in the last several years.

vidyohs October 5, 2011 at 6:14 pm

Useful idiot.

Methinks1776 October 5, 2011 at 9:09 pm

In what way is he useful?

Sam Grove October 5, 2011 at 11:17 pm

Your assumption seems to be that people in business have psychological responses at variance with the norm.

muirgeo October 5, 2011 at 5:19 pm

Funny how the socailism waited until AFTER Reagan, Thatcher, Bush 1 & 2 to do it’s damage.

Ken October 5, 2011 at 5:24 pm

That’s right, the Democrat/leftist enterprises of the Great Depression, WWII, the Cold War, Vietnam and stagflation occurred after Reagan, Thatcher, Bush 1&2… Wait? What? All those things occurred before Reagan, Thatcher, etc? Huh!

Is picking up a history book really so hard, muirgeo?

Regards,
Ken

Observer October 5, 2011 at 5:30 pm

Ken

Last I looked, the Depression started in 1929, during a Republican administration, Japan and Germany declared war on us, following a sneak attack a Pearl Harbor, and, according to you, RR won the Cold War (which therefore had to be a good thing—otherwise why didn’t he just quit it 2 weeks into his term).

Ken October 5, 2011 at 5:44 pm

“Last I looked, the Depression started in 1929, during a Republican administration”

Republicans do all sorts of socialist things too, like intervening massively into the economy and increasing the federal spending by 57%, the way Hoover did. Also, the Great Depression was coming to a close in 1933, but FDR fixed that.

Yes, Japan and German did start the war. Guess what type of government German had: socialist. While Japan wasn’t explicitly socialist, it certainly was collectivist.

Ronald Reagan ended the Cold War, but began by another belligerent, you guessed it, socialist nation.

Regards,
Ken

Economic Freedom October 5, 2011 at 8:57 pm

@ Ken:

Yes, Japan and German did start the war.

Slight correction:

Japan, Germany, and the Soviet Union started WWII.

The formal start of the war in Europe occurred in September 1939 when Germany invaded Poland along the latter’s western border and the Soviet Union, a few weeks later, invaded Poland along the latter’s eastern border (there was a narrow strip of buffer zone between the two occupiers known as the “Governement Generale”). The conspiracy between Germany and the Soviet Union to make war had been codified in writing a month or so before when Hitler and Stalin (through their foreign ministers, Ribbentropp and Molotov) signed a Non-Aggression Pact along with a “secret protocol” to divide up eastern Europe and the Baltic states into mutually exclusive “spheres of influence.” The minutes from this secret protocol became known during the Nuremberg Trials after the war.

muirgeo October 5, 2011 at 5:48 pm

Ken,

You are one big Dopasaurus… That made no sense at all.

Ken October 5, 2011 at 5:57 pm

Yep. Only Dopasauruses understand time lines and historical facts, amaright?

Regards,
Ken

kyle8 October 5, 2011 at 6:22 pm

Your comments have moved from the ludicrous to the sublime.

vidyohs October 5, 2011 at 7:37 pm

Oh did it my little muirhuahua?

Between FDR’s election and death, we had social security, federalization of the school systems, payroll withholding imposed for income taxes, welfare, the 1935 National Labor Relations Act, Public Employees unions (predominantly teacher’s unions), communists in every department of the government sending secret info to the Soviets and protected and defended to the bitter end by FDR administration officials, etc. et.al.

muirhuahua, you are just so easy to shoot down with actual documented history that it is a wonder you ever get off the porch and try to run with the big dogs.

simon... October 5, 2011 at 4:32 pm

I think there is some unintentional element of truth in Morici’s claims. A lot of money we pay to China comes back as a non-productive (counter-productive?) “investment” into our government, and that probably IS “…a tax on domestic demand…”.
If only taxing US consumers of Chinese-made goods had a chance of solving this problem…

Stone Glasgow October 5, 2011 at 5:56 pm

Buying a Chinese toy is a trade. It matters not what the toy-maker does with his dollars after the trade is complete. Dollars are simply a form of property, just like toys.

Should Chinese citizens care if you loan toys to the Chinese government?

Economic Freedom October 5, 2011 at 6:00 pm

“investment” into our government . . . probably IS “…a tax on domestic demand…”

The reverse is the truth. Selling gov’t bonds to US citizens diverts domestic demand; selling the bonds to foreigners frees up domestic demand.

The problem is not that the Chinese buy US gov’t bonds; the problem is that the US gov’t sells them. Radically cut gov’t spending and the problem will be solved.

vidyohs October 5, 2011 at 6:17 pm

Oh no!!!! There you go again……you libertarians…..cut spending, cut spending, cut spending, as if we can’t extend the debt from its present horizon of 75 years out, to a new horizon of 90 years out. Hell, everyone of any note knows that credit can be income! Get with the program.

Observer October 5, 2011 at 6:47 pm

Economic Freedom writes, “Radically cut gov’t spending and the problem will be solved.”

Finally, someone confronts the reality.

The US Gov’t does not want to reduce its sales of bonds to China, for to do such will cut Chinese imports and reduce the number of jobs being created in China and reduced the number of jobs being destroyed in the United States.

There problem with people who don’t understand economics is that they do not understand that trade cannot take place without a mechanism to convert currencies. The control of this mechanism will always be in the hands of gov’t, which is why trade is never free, it is just what gov’ts tolerate for their own purposes.

There were two ways to bring China into the modern world. Foreign aid, paid for with taxes, or transfer of jobs from the US to China. We could have raised taxes and sent the money to China, which could then use the money to buy machinery, etc., but that would have never happened, politically. Steelworkers would have never paid taxes to build steel factories in China.

So, instead, China’s prosperity has been built by the sacrifice of America’s lower classes .

Methinks1776 October 5, 2011 at 9:16 pm

Yep. America’s “lower class” has sacrificed a more impoverished life for a richer one. They can now consume things they had no hope of consuming before China so generously lowered prices for Americans at the expense of its own citizenry.

My heart bleeds for the ipad insecurity of the American “lower class”.

vidyohs October 5, 2011 at 9:29 pm

The sacrifice of America’s lower classes? Here I thought you and the other loonies were offering their success up as the result of Chinese slave labor.

Make up your mind, boy.

Invisible Backhand October 5, 2011 at 4:32 pm

I’m not sure if ‘asset’ means the same thing in economics as it does in accounting. And it can be hard to tell which things are assets, a consumable like gasoline purchased by a distributor for sale is an asset but purchased by me for my car isn’t.

We also know there is a correlation between trade surplus = lower unemployment, but it’s hard to get that past the gauntlet of idiots like this guy:

http://i.imgur.com/66OrO.png

Economic Freedom October 5, 2011 at 5:35 pm

“If Trade Surpluses Are So Great, the 1930s Should Have Been a Booming Decade”

http://cafehayek.com/2006/12/if_trade_surplu.html

The incessant fretting over the U.S. trade deficit is unwarranted. As I point out (probably too) often, the trade deficit, along with its broader cousin, the current-account deficit, are no cause for concern.

Earlier today I visited the National Bureau of Economic Research’s Macrohistory Database. I clicked on Chapter 7 and then looked at the value of U.S. imports and the value of U.S. exports for each of the 120 months during the 1930s.

Turns out that for only 18 of the 120 months of that dreary decade did the United States run a trade deficit (that is, imported more, value-wise, than it exported). For each of the remaining 102 months of the decade of the 1930s the U.S. ran a trade surplus.

On an annual basis, the only year of the decade of the 1930s that the U.S. ran a trade deficit was 1936; in each of the other nine years the U.S. ran a trade surplus.

And for the Depression decade taken as a whole, the U.S. ran a substantial trade surplus. Exports over those economically challenging ten years totaled $26.05 billion while imports totaled only $21.13 billion. In other words, the U.S. trade surplus during the entirety of the 1930s was nearly 19 percent the size of the total value of U.S. exports during that decade.

During the Great Depression of the 1930s, we had sustained structural unemployment sometimes as high as 25%. As the National Bureau of Economic Research Macrohistory Database shows, we also ran a trade surplus during those years. The only correlation, therefore, is an inverse one. But even that proves nothing.

In any case, the facts contradict your fantasy.

John Dewey October 5, 2011 at 5:46 pm

“In any case, the facts contradict your fantasy”

Which is a surprise to no one.

Invisible Backhand October 5, 2011 at 6:58 pm
ben October 5, 2011 at 5:00 pm

Don, is my thinking on the following two propositions correct:

a) A capital account surplus has the effect of raising capital intensity, surrounding US workers with more capital, thus increasing wages. Correct?

b) There is no limit to this process: a capital account surplus/current account deficit can be run indefinitely because there is no limit to the amount of capital that can be invested (yes: declining marginal returns will presumably at some point slow or stop the process, but that is different to ‘running out of money’ or ‘running out of land to sell’, etc)

Martin Brock October 5, 2011 at 5:29 pm

a. Not necessarily. A capital account surplus includes the foreign purchase of Treasury securities, and spending from the Treasury need not surround U.S. workers with more capital. It can even do the opposite. As Greenspan has noted, in the recent past, the capital account surplus included the foreign purchase of many mortgage backed securities driving an ultimately unproductive housing bubble.

b. A capital account surplus can exist indefinitely in theory, but what good is this theory? The theory involves assumptions. Are these assumptions true?

Don Boudreaux October 5, 2011 at 7:16 pm

But if Uncle Sam will borrow anyway, loans by foreigners free up American dollars to be invested privately.

ErikOlsen October 5, 2011 at 7:37 pm

Isn’t the amount of capital simply MV? and does it make any difference who holds M? If anything, I would think that velocity arguably increases if demand is encouraged by low cost goods. But you can’t pay a chinese worked in dollars. So they either need to exchange or buy something in the US (investment included).

vikingvista October 7, 2011 at 3:16 am

“Isn’t the amount of capital simply MV?”

No, that is total spending. The *exchange* equation doesn’t account for capital not traded, and more traded things than just capital are accounted for.

“I would think that velocity arguably increases if demand is encouraged by low cost goods.”

Why? If prices are lower, less money is needed for a greater number of purchases, so the money reuse rate, or velocity, might actually fall. You might expect the number of *transactions* to increase when prices fall, but who is to say the increase in T overcomes the fall in P? Total nominal spending (PT or MV) needn’t increase with real economic growth, if the same level of nominal spending is allowing people to acquire a greater quantity or quality of what they desire, due to falling prices. Many economists long thought the expansionary time of the late 19th century was actually a long-lived recession, because nominal GDP (total spending) fell.

The goal, is a sustained long term increase in T. But with 3 degrees of freedom, P, M, V, and PT=MV can be doing anything to get there. The equation is true, but just not very useful, except may be in posthoc work if you can go back and estimate what P, M, and PT happened to be. For example, if in the late 19th century M was roughly fixed, and PT was falling, we can conclude V was falling even while T was increasing. It just means P was falling faster than T was increasing.

vikingvista October 5, 2011 at 5:08 pm

It is interesting that you have to point out that obvious falsehood even to a nonhyperpartisan professional and academic economist. So, what is your opinion of your profession as a whole?

Stone Glasgow October 5, 2011 at 5:47 pm

How are dollars directly traded from a Chinese citizen for RMB held by an American counted? Same as if the Chinese man purchases Texas land?

Mesa Econoguy October 5, 2011 at 7:10 pm

Slightly related: Bruce Bartlett was on Squawk Box this morning saying inadequate AD is the current problem, though he didn’t point to the trade deficit as a driver.

[He also made the demonstrably false and idiotic claim that regulation is not appreciably greater right now than it was in 2000, but that's for a different thread.]

I nominate Don to get on every single “What’s Wrong with the Economy/Job Creation” topic on every single TV channel, and give his outstanding car-mechanic-prescribing-gas-for-everything-solution analogy/explanation.

That is the clearest refutation of nonsense like this that I have come across.

Methinks1776 October 5, 2011 at 9:21 pm

I saw that (well, heard – I can’t bring myself to look at them). Bruce argued that there isn’t appreciably more regulation. The hosts mentioned Obamacare and Dudd-Frank. Bruce responded that those have not gone into effect yet and that made sense to Bruce because someone failed to inform him that markets are forward looking. Any monkey can get on CNBC.

I wasn’t all that impressed with El Erian’s middle of the road Keynesonomics either.

We would all be better off if Don, Russ, Kling and Horwitz became regulars on the financial news networks. I wouldn’t have to mute it as often.

Economic Freedom October 5, 2011 at 7:52 pm

NEWS FLASH:

Bit of a sad digression:

Just heard that Steve Jobs died. He was 56.

Methinks1776 October 5, 2011 at 9:22 pm

So young. So sad.

Stone Glasgow October 5, 2011 at 9:50 pm

Arguably the most productive man who ever lived. Very sad to lose him.

anthonyl October 5, 2011 at 9:57 pm

Not a digression at all! One of the most creative and productive individuals of our time. He will be greatly missed!

Observer October 5, 2011 at 8:16 pm

Just heard that Steve Jobs died. He was 56.

more than sad and more than a digression

Replevin October 5, 2011 at 9:48 pm

Don,

I’m new to economics and receptive to your ideas, and I’m genuinely wondering…

(1) Why must dollars spent overseas be invested back in the U.S.? Couldn’t a Chinese exporter who receives dollars for his goods/services simply trade those dollars to a German for other goods/services, who then uses the dollars to buy Japanese goods/services… ad infinitum?

(2) If those dollars do all return to the U.S. and create a capital account surplus, doesn’t all that investment tend to create asset bubbles? If a growing capital account surplus is invested heavily in American stocks, for example, doesn’t that have a tendency to overvalue American companies (e.g. dot-coms)? Or real estate? Or wherever else that capital surplus finds itself?

For these reasons, couldn’t a perpetual and growing capital account surplus, as opposed to a trade balance, be unhealthy for the economy? Thank you!

Economic Freedom October 5, 2011 at 10:58 pm

I’m new to economics and receptive to your ideas,

Welcome!

(1) Why must dollars spent overseas be invested back in the U.S.?

They don’t have to be invested back in the U.S. (in the sense of an asset purchase) but they do eventually have to be spent in the U.S. if they are to be spent at all.

Couldn’t a Chinese exporter who receives dollars for his goods/services simply trade those dollars to a German for other goods/services,

Sure. But why would the German be willing to accept dollars in the first place?

who then uses the dollars to buy Japanese goods/services

Sure. But why would the Japanese be willing to accept dollars?

… ad infinitum?

The only reason someone is willing to accept dollars is because he either wants to spend them in the U.S., or he wants to trade with someone who wants to spend them in the U.S.

(2) If those dollars do all return to the U.S. and create a capital account surplus, doesn’t all that investment tend to create asset bubbles?

Asset bubbles are caused by central bank “easy money” policies. In the absence of such policies, the unhampered market has automatic corrective mechanisms that prevent such bubbles; viz., as investments expand in Industry X, competition intensifies; as competition intensifies, the previous high profit margins — which were the incentive for the increased investment in the first place — get knocked down to something just above the industry’s costs of production, thus returning to businesses a so-called “average rate of profit.” At that point, there’s no longer any incentive to invest in Industry X and an asset bubble will not occur.

If a growing capital account surplus is invested heavily in American stocks, for example, doesn’t that have a tendency to overvalue American companies (e.g. dot-coms)? Or real estate? Or wherever else that capital surplus finds itself?

The dot-com bubble and the housing bubble were both caused by Federal Reserve easy money policies. Other government interventions may have aggravated the situation (e.g., the Community Reinvestment Act, pressure on banks to loosen standards for lending, etc.) but credit expansion by the Fed is the main one.

For these reasons, couldn’t a perpetual and growing capital account surplus, as opposed to a trade balance, be unhealthy for the economy? Thank you!

Investors only over-invest when they have been misled by various economic signals such as prices and the rate of interest, both of which, again, are caused by central bank policies. Regarding “balanced trade,” the sum of the capital accounts surplus and the current accounts deficit equals zero.

anthonyl October 5, 2011 at 9:49 pm

Don, you just keep slaying that dragon. It is out of control! Now when I buy something from Target, I don’t shop at Wall-Mart just a preference but same thing, I pay in dollars. What does target pay the manufacturer in China? Answer… Who cares! I’m better off because of the trade, Target is happy to trade with the manufacturer, the manufacturer is happy to do business with Target. Why do these deficit fire-belchers want to rain on our parade? Sorry for mixing metaphors. Why do they hate all these obviously happy people?

Observer October 5, 2011 at 9:59 pm

Per Dugger, link elsewhere:

Most observers point to the fall of the Berlin Wall on November 9, 1989, as the watershed moment when
the global economy entered a new era. Symbolically this was important, but the more important
economic event was January 1, 1994, when China devalued the yuan by 50%. On that day hundreds of
millions of Chinese workers were offered on the world labor market in a half-off sale and began drawing
away the manufacturing jobs that were once the backbone of the American middle class. Since then, US
median household income stagnated. The Census Bureau recently reported that median household
income in 2010 was the lowest since 1997.
US politics have yet to adapt to this hyper-competitive global economy bulging with cheap labor. Instead,
policymakers papered over cracks in the foundation of the American economy with tax cuts and stimulus
checks starting in 2001. The Fed added its own plaster through low interest rates and eventually
“Quantitative Easing”. There were no initiatives to make American workers more competitive. Nor was
there much effort to break away from a Cold War fiscal strategy that encouraged debt-financed
consumption and suburban expansion. Today, old-growth sectors continue to enjoy the budget
advantages of tax breaks and subsidies that are barriers for new sectors poised to grow in the future. As
special interests align with increasingly polarized parties, elected officials fight for remaining budget
resources on behalf of their backers.

Ken October 6, 2011 at 3:03 am

Observer,

There are many flaws in using the median income as an indicator of the middle class. First and foremost, the median income referred to deals with household income, not per capita, and certainly not per worker. Additionally, focusing on income rather than total compensation (income + benefits), completely ignores that total compensation has grown, even for the median household.

Not understanding statistics can lead to all sorts of misleading and just plain wrong conclusions.

Regards,
Ken

Dan H October 5, 2011 at 10:02 pm

If ever one man unintentionally destroyed the mercantilist premises of marxism, or the demand side argument of Keynes, it was Steve Jobs, who proved that innovation is the ultimate driver of wealth creation. And we are all better off because of him.

Godspeed, Mr. Jobs.

Ed October 5, 2011 at 10:46 pm

Professor Morici is correct: Y = C + I + (G – T) + (Ex – Im)

The trade (US$) surplus accruing to China mostly comes back to the US through purchases of USG debt; it does not create offsetting demand for for US real production. There is a net decline in US national income as a direct result of China’s undervalued currency.

Do they offer macro courses at GMU??

Don Boudreaux October 5, 2011 at 11:28 pm

So – does Uncle Sam not spend the dollars he borrows from foreigners? If you answer ‘yes he does,’ then you concede my point. If you answer ‘no he doesn’t,’ then what DOES he do with those borrowed bucks?

Ed October 6, 2011 at 10:10 pm

Government spending is accounted for by the ‘G’ term in the equation.

Don’t take my word for it. Ask an international trade specialist in your own department.

no one important October 5, 2011 at 11:41 pm

I thought the whole pretense of the trillions of new Federal debt in recent years was to stimulate demand? Apparently government spending magically becomes a divisor when the union shills shift focus to pushing mercantilism instead of public works projects.

Ken October 6, 2011 at 2:59 am
Ed October 6, 2011 at 10:16 pm

It isn’t a model, it is an accounting identity.

Ken October 6, 2011 at 10:31 pm

Ed,

It’s often incorrectly used as a model to demonstrate how government can supposedly increase aggregate demand. People (Keynesians) often claim that if there’s slack somewhere in the economy, simply increase G, as if that number is completely independent of the other variables in that identity.

Regards,
Ken

Economic Freedom October 7, 2011 at 3:40 pm

it is an accounting identity.

In other words, a mere tautology. That accounts for its uselessness.

John Dewey October 6, 2011 at 1:48 pm

Uh, Ed, do you understand what the “G” in that equation stands for?

vikingvista October 6, 2011 at 4:03 pm

“Professor Morici is correct: Y = C + I + (G – T) + (Ex – Im)”

I was hoping you were actually going to use that equation in your reply, but you did not. But for future reference, please notice that identity has 6 whopping degrees of freedom. *Whatever* happens to any 5 of those variables on the right, *anything* can still happen to Y. For example, Ex-Im can increase, and Y can still decrease for many reasons, like a drop in I, increase in T, or drop in C. It may also increase even while both Ex and Im dramatically plummet.

Specifically, some of the arguments on this blog are meant to show that efforts to force Ex>Im do in fact lead to declining Ex, declining Im, declining I, and declining C.

Unfortunately, people use that simple equation as a substitute for any kind of real economic reasoning.

Ed October 6, 2011 at 10:05 pm

OK, I will use the equation in a reply. Here goes – -

While holding C, I, G, T, & Ex constant; if Im increases, Y will decrease.

vikingvista October 6, 2011 at 11:21 pm

Outstanding. Now, what makes you think C, I, G, T, and Ex remain constant?

Economic Freedom October 7, 2011 at 3:54 am

On Planet Ed, people automatically adapt their economic behavior to agree with the fixed values assigned to arithmetic symbols, rather than adapting the value of the symbols to agree with the way people actually behave in the economy. Very neat.

Wrong, but neat.

Observer October 5, 2011 at 10:49 pm

Ed

Your post is too funny!!!!!!!!!!!!!

Ed October 6, 2011 at 7:31 am

J. M. Keynes is to Adam Smith as Einstein is to Isaac Newton.

(That should keep this thread going for a while longer)

Economic Freedom October 6, 2011 at 12:38 pm

J. M. Keynes is to Adam Smith as Einstein is to Isaac Newton.

And you’re the Fourth of the Three Musketeers.

Fred October 6, 2011 at 2:20 pm

Keynes is to Adam Smith as Flat-Earthers is to Galileo.

Bill October 6, 2011 at 12:32 pm

Morici must be an embarrassment for the other Maryland faculty. I spent a sabbatical at College Park a few years ago, and I was impressed with the economists, not only in the Economics Department, but in the Department of Agricultural and Resource Economics.

vikingvista October 6, 2011 at 4:05 pm

Maybe he’s aspiring to a political appointment.

Spatial Orientation October 10, 2011 at 8:57 am

Don’s appearance on Stossel with Peter Morici was priceless! Great stuff…

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