In his 2005 annual letter to his Berkshire Hathaway shareholders, Warren Buffett offers his thoughts on the trade deficit.
He’s a far better investor than he is economist.
Like so many others, Buffett confuses a trade deficit with debt. But as I’ve explained before, no way, no how is a trade deficit indentical with debt. (See here, here, here, here, here, here, here, here, and here.)
But let me address a misunderstanding that I believe I haven’t yet addressed at Cafe Hayek.
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Buffett no doubt believes that dollars held by foreigners represent debt owed by Americans to foreigners. Only in the most irrelevant and formal sense is this belief valid. Each U.S. dollar is a Federal Reserve Note, issued by a U.S. government institution (the Fed) and formally redeemable by that U.S. institution. But redeemable for what? Answer: another Federal Reserve Note of the same value.
In fact, dollars held by foreigners are not debt in any economically relevant sense.
"But can’t foreigners spend these dollars on U.S. goods, services, or assets?!" I hear someone (Buffet, perhaps) asking. Of course dollars can be spent in this way; that’s the only reason foreigners accept dollars in exchange for the things they sell. But this fact doesn’t make dollars debt.
Suppose my next-door neighbor in Virginia agrees to mow my lawn for $10. He mows my lawn and I immediately give him a $10 bill. No debt is created. I owe my neigbor nothing; my neighbor owes me nothing. My neighbor can now spend this $10 bill on whatever he chooses. I no longer have this $10 to spend.
Does anyone worry that my neighbor has an additional $10 bill in his wallet that he might whip out at any time to buy something priced in dollars? This $10 can indeed be used as a claim on ten-dollars worth of U.S. output or assets. But it ain’t debt. No one owes my neighbor anything as a consequence of his ownership of that $10 bill.
Change the example only slightly. Suppose I live, not in Virginia, but in Maine just barely on the U.S. side of the Canada-U.S. border. My next-door neighbor is a Canadian citizen living in Canada. He mows my lawn; I pay him ten U.S. dollars. As long as my neighbor holds that $10 bill, the U.S. current-account deficit is higher by $10. (I outsourced my mowing to Canada — importing $10 worth of services from abroad.)
Is there any reason for George Bush, Alan Greenspan, Britney Spears, Don Boudreaux, Warren Buffett, Jimmy Buffett, or any one else to worry about my Canadian neigbhor holding this $10? Is the situation any different, economically, when my neighbor (and trading partner) happens to be Canadian than when he’s a Virginian? Of course not.
But the Oracle of Omaha does worry. He shouldn’t. And nor should anyone else.
Thanks to Andy Roth of the Club for Growth (and also a student at GMU Economics) for alerting me to Buffett’s annual letter.