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The Presumptions of Ptolemaic Economics Die Hard, Part II

Posted By Don Boudreaux On October 4, 2011 @ 9:27 am In Balance of Payments,Country Problems,Myths and Fallacies,Seen and Unseen,Trade | Comments Disabled

Addressing here again this e-mail to me yesterday from C. Fred Bergsten:

Professor Boudreaux,

Your comment [1] on my op-ed for last week is ridiculous.

Of course the American seller of land to the Chinese COULD buy US pharmaceuticals.  But she could also save all the proceeds.  Or use it to buy more imports from China and elsewhere.

We would never have a trade deficit in the first place if your postulated scenario were to occur in the real world.  Come on!

Sincerely,

C. Fred Bergsten

In this post [2] yesterday, I addressed the most serious flaw in this e-mail, namely, a U.S. current-account (“trade”) deficit is simply another name for a U.S. capital-account surplus.  (Mark Perry has more precise data [3].)  So even if we accept unalloyed Keynesianism – that is, the most vigorous case that economic health is positively promoted by more spending – Mr. Bergsten’s allegation that eliminating the U.S. trade deficit is a costless (!) means of increasing the employment rate in America remains naive.  Reducing the current-account deficit would simultaneously reduce capital inflows into the U.S.

(Note: I will not deal here with arguments that an increasing U.S. capital-account surplus threatens America by turning over more assets in the U.S. to non-Americans.  That argument is entirely different from the one that Mr. Bergsten makes, which is that the U.S. trade deficit means that there is less aggregate demand in America and, hence, American unemployment is thereby kept unnecessarily high.)

Take another look at Mr. Bergsten’s second paragraph where he says:

Of course the American seller of land to the Chinese COULD buy US pharmaceuticals.  But she could also save all the proceeds.  Or use it to buy more imports from China and elsewhere.

Yes.  He’s correct.  But note that:

(1) If she (the American seller of land to the Chinese) saves all of the proceeds the problem is hoarding (which I will assume here is, in fact, a problem).  The nationality of the hoarder is irrelevant.  Suppose the dollars that the Chinese person used to buy the land had instead never gone to China as dollars spent by Americans on Chinese exports.  Suppose instead that the American buyers had bought their goods from American producers and then these American producers then hoarded the dollars.  The result would be the same (problem or not) that Mr. Bergsten mistakenly attributes to the U.S. trade deficit but without any resulting increase in the U.S. trade deficit.

(2) If instead, as Mr. Bergsten postulates as another possibility, the American seller of land then buys “more imports from China and elsewhere” – so what?  What do these foreign exporters do with their newly earned dollars?  Answer: they either spend these dollars buying American exports, or invest these dollars in dollar-denominated assets (including possibly hoarding dollars themselves).  With this possibility, Mr. Bergsten has simply added another round to trade – a round to be analyzed just as we analyze the first round.  (Hint: in the second round the dollars in any increase in the U.S. current-account deficit return to the U.S. as investment, unless they are hoarded – in which case, see my above point that there is nothing unique about foreigners’ ability or propensity to hoard dollars.  [I ignore here, for the sake of argument, the real-cash-balance effect.])

But the paragraph that I find most mysterious in Mr. Bergsten’s brief e-mail is his third one:

We would never have a trade deficit in the first place if your postulated scenario were to occur in the real world.  Come on!

This claim is simply wrong.  If Americans buy, say, $1M worth of goods from China and then the Chinese exporter uses this $1M to buy land in Texas or Florida or Maine – or if the Chinese exporter uses it to buy stock in American corporations – or lends it to Uncle Sam, to the Fairfax County, VA, school district, or to me personally – or uses it to fund FDI in the U.S. – those purchases are recorded in the capital account (not the current account).  The transaction I describe in my initial letter – my “postulated scenario” – will in fact increase America’s trade deficit (or, to be precise, if the U.S. had a trade surplus, it would reduce that surplus).

…..

I understand that Mr. Bergsten’s e-mail to me is short – and probably dashed off quickly.  One must be forgiving when evaluating the contents of things written and said informally.  But insofar as Mr. Bergsten actually believes what he wrote to me in his e-mail, he’s quite mistaken about the meaning, causes, and consequences of a U.S. current-account deficit (nee: capital-account surplus).

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[1] Your comment: http://cafehayek.com/2011/09/ptolemaic-economics.html

[2] this post: http://cafehayek.com/2011/10/the-presumptions-of-ptolemaic-economics-die-hard.html

[3] Mark Perry has more precise data: http://www.dailymarkets.com/economy/2011/10/03/there-really-is-no-trade-imbalance-to-eliminate-so-eliminating-a-fictional-deficit-wont-create-jobs/

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