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Why Do Foreign Suppliers Accept Dollars?

Hall of Record’s Bruce Hall rejects my nonchalance about the trade deficit in favor of Warren Buffett’s deep anxiety over it.  (See also this other of my posts.)

Mr. Hall argues that importing goods and services “from a country 8,000 miles away … unless the equation is balanced by that country buying goods and services from the U.S. …there will ultimately be a negative economic impact as the U.S. losses it’s [sic] ability to generate wealth internally.”

The reason Mr. Hall uses the example of a country 8,000 miles away is to distinguish imports from such a country from the case in my earlier example, in which I imported services from my Canadian next-door neighbor.  Like me, Mr. Hall isn’t bothered by imports from someone who lives close to the U.S.: “The Canadian across the river is likely to use his newfound income to purchase goods or services from the area [presumably the U.S.].  The economy of the area is infused with income and spending that enriches the area.”

But unlike me, Mr. Hall sees the example of the close-in Canadian supplier as being of little relevance to the case of importing goods from distant countries: “The purchase of goods from a country 8,000 miles away that does not reciprocate, brings goods into the country while moving the wealth generated from production out of the country.”

I respectfully disagree. I continue to see no difference between importing goods from across the river and from across the ocean. Let’s use India as an example of a distant country from which Americans import goods and services. The Indian supplier sells (say) textiles to Americans. Americans pay for these textiles with dollars.

Why does the Indian supplier accept dollars in return for his valuable merchandise?  The reason is obvious; it’s the same reason that Mr. Hall, and I, and everyone else accepts dollars: because he knows that he can use these dollars to buy things that he fancies.  That’s the only reason.

He might want to buy consumer goods or services; he might want to buy producer goods or services; he might want to buy real-estate, equity shares, or debt instruments.  No matter.  He is surely no more enamored of dead American statesmen than I am – and as much as I admire George Washington and Ben Franklin, I don’t accept currency sporting their portraits because I long to gaze at engravings of their faces.  I accept dollars only because I aim to spend these dollars.

The same is true of the Indian textile supplier no less than it is true of the Canadian who mows my lawn.  The fact that the Indian lives thousands of miles away doesn’t mean that different reasons motivate his willingness to accept dollars in exchange for his products.

In short, Mr. Hall is right that the Canadian will spend his dollars in the U.S. But so, too, will the Indian.  (Yes, yes; the Indian might do so indirectly – by converting his dollars to rupees.  But whoever gives him valuable rupees in return for his dollars does so only because that person knows that the dollars are exchangeable for dollar-denominated goods, services, and assets.)  Foreigners accept dollars because they eventually want to spend these dollars on U.S. output or assets.

And, yes, it’s also true that foreigners can hold dollars indefinitely, just as Americans can.  But even if foreigners practice the most extreme form of not spending their dollars – say, burning them – this would be not bad news, but good news for the U.S. economy.  But that’s another post.