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The Presumptions of Ptolemaic Economics Die Hard

Posted By Don Boudreaux On October 3, 2011 @ 7:29 pm In Balance of Payments,Myths and Fallacies,Trade | Comments Disabled

My friend Donald Marsh sent my letter [1] addressing C. Fred Bergsten’s recent New York Times op-ed to Mr. Bergsten.  Today comes this e-mail:

Professor Boudreaux,

Your comment 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

First of all – and despite calling my argument “ridiculous” – Mr. Bergsten, in his second paragraph, concedes that my scenario is possible.  But apparently he believes it to be so far-fetched that it deserves his derision.

He misses my larger point that much of the U.S. trade deficit “comes back” as spending power to the U.S.  I offered in my letter just one example to show that his suggestion that the trade deficit necessarily reduces demand for U.S.-made outputs is mistaken.

So let’s mention some other ways in which the dollars in the U.S trade deficit come back as spending power to America:

(1) if foreigners buy stock in U.S. firms.  (U.S. trade deficit rises; sellers of stock have more money to spend – and U.S. firms have lower costs of capital.)

(2) if foreigners directly invest in America: those investment expenditures raise America’s trade deficit, but there’s no reduction in domestic spending of the sort that Mr. Bergsten implies in his NYT op-ed.

(3) if foreigners lend to Americans: the U.S. trade deficit rises.  If Americans spend the borrowed funds (and why else would they borrow them?) there’s no reason at all why total expenditures need be lower in America in this case than if Americans never imported in the first place and instead spent all the money directly on the good and services that (in this hypothetical) they buy with dollars borrowed from foreigners.

Now Mr. Bergsten might worry that people hoard dollars (see his e-mail to me).  But even if we grant that that is a problem, it has nothing to do with the trade deficit.  The same problems would be created if Americans don’t trade at all with foreigners (or trade only in a “balanced” way) and yet hoard lots of dollars themselves.

There are other problems with Mr. Bergsten’s response to my letter – problems that I’ll address in a subsequent post.  Suffice it here to say that his presumption that U.S. trade deficit = reduced aggregate demand in the U.S. economy is – while common – utterly without merit.

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[1] my letter: http://cafehayek.com/2011/09/ptolemaic-economics.html

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