Another Open Letter to Peter Morici

by Don Boudreaux on January 5, 2012

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

Dear Peter:

At FoxNews.com today you write that “dollars sent abroad to purchase oil and consumer goods from China that do not return to purchase U.S. exports are lost purchasing power.  Consequently, the U.S. economy is expanding at about 2 to 2.5 percent a year instead of the 4 to 5 percent pace that is possible after a long and deep recession”  (“What Can We Expect From the First Jobs Report of 2012?“).

You frequently repeat the theme that a U.S. trade deficit necessarily means lamentably lost purchasing power in America.  I don’t now wish to challenge you again on the general question of the nature, causes, and consequences of a trade deficit.  On this matter you and I fundamentally disagree.  I cannot, though, resist demonstrating your error on a more-specific point, to wit: your erroneous identification of a trade deficit with lost purchasing power.

Suppose that in 2012 Americans import $200 billion more than we imported in 2011, but with no change in our exports.  America’s trade deficit will then rise by $200 billion.  Further suppose that foreigners lend every cent of this $200 billion to Uncle Sam, who then spends it in America.  You’ll agree that this scenario is quite realistic.

Surely, though, you also agree that this $200 billion that returns as a loan to Uncle Sam becomes purchasing power in America – purchasing power exactly equal to the increase in our trade deficit of $200 billion.

Surely you agree, in other words, that had Uncle Sam instead acquired this $200 billion to spend by confiscating it on the docks just before it was to be spent by consumers on imports, the amount of purchasing power in America would be no higher than it is if the $200 billion is spent on imports and then borrowed by Uncle Sam to finance his spending.  In the former case America’s trade deficit doesn’t rise while in the latter it rises by $200 billion – yet the effect on purchasing power here is the same in both cases.

So unless you’re prepared to argue that dollars borrowed from foreigners and then spent in the U.S. by Uncle Sam are not “purchasing power” in the U.S., you must agree that a rising U.S. trade deficit does not necessarily reduce purchasing power in the U.S.

Of course, the above example is just one of countless ways that dollars in America’s trade deficit return to America as purchasing power.  But all I need is one realistic scenario, which I’ve provided, to expose the fatal error in your analysis.

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

P.S.  I thank Greg Staff for alerting me to your essay.

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