A Poole of Wisdom

by Don Boudreaux on February 21, 2006

in Trade

William Poole, President of the St. Louis Fed, nicely explains some facts about the trade deficit that too often are ignored or remain unlearned.  (The emphasis is mine.)

The most widely cited measure of the U.S. external imbalance is the trade deficit—the difference between U.S. exports and imports of goods and services. More generally, it is useful to consider the broader concept of the current account, which includes current earnings on capital as well as trade in goods and services. A corresponding account on the other side of the ledger, known as the “Capital and Financial Account,” measures the international flow of capital assets. Putting aside errors and omissions in the data, a current account deficit is necessarily equal to a capital account surplus. A country in this position—like the United States today—is exporting more capital claims than it is importing. Put another way, international investors are bringing more capital to the United States than U.S. investors are sending abroad.

A common mistake is to treat international capital flows as though they are passively responding to what is happening in the current account. The current account deficit, some say, is financed by U.S. borrowing abroad. In fact, international investors buy U.S. assets not for the purpose of financing the U.S. current account deficit but because they believe these are sound investments promising a  good combination of safety and return. Moreover, many of these investments 
have nothing whatsoever to do with borrowing in the conventional meaning of the word, but instead involve purchases of land, businesses, and common stock in the United States. Foreign auto companies, for example, have purchased land and built manufacturing plants in the United States. Clearly, foreign auto producers have established these facilities because of the prospective returns from building vehicles in the United States and not for the purpose of financing the U.S. current account deficit. This simple example should make clear that a careful analysis of the nature of international capital flows is necessary before offering judgments about risks posed by the U.S. current account deficit.


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