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A Follow-up to Ian Fletcher

Dear Ian:

Thanks for your follow-up.  You write “If you, rather than I, have a certain $100 bill, you’re richer than you would be if you didn’t have it, and I am poorer.  This isn’t even a matter of economics.  It’s just accounting.”

You’re correct: it’s not economics.  It’s a bad example based on at least two faulty implicit assumptions.  One is the assumption that the world’s stock of resources or wealth is fixed.  Another is that money is wealth (rather than claims on the goods and services that really are wealth).

Because trade is voluntary, trade is mutually beneficial and, hence, itself creates wealth.  Both parties to any trade gain.  How did I come by the $100 bill?  Likely by producing $100 worth of value that would otherwise not have existed.  Suppose I’m a tailor in Shanghai who makes a new shirt.  If you give me the $100 in exchange for my shirt, I now have the $100 bill that you once owned.  If you bought the shirt for consumption, an accountant might indeed say that you are $100 poorer, but clearly you are not worse off.  (In utility terms, you are better off.)  If, instead, you bought the shirt to resell at your haberdashery in Hoboken, then even an accountant would not reckon you to be made poorer by this exchange.

Only if you regard – which, I fear, you do – real wealth as being fixed in quantity or regard all consumption as being economically destructive can you conclude from your simple example that if I come by a $100 bill honestly (say, by persuading you to spend it on something that I sell to you) that my gain is your loss.

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA  22030

To Cafe Patrons: My original plan was to share with you my e-mail exchanges with Ian Fletcher, but his responses so far to my notes indicate that his understanding of trade is so completely primitive that my replies to him, if I posted them here, would merely insult your intelligence and waste your valuable time.

In an e-mail that he just sent to me he simply assumes that a $1 increase in America’s current-account (“trade”) deficit necessarily means that the stock of assets owned by Americans falls by $1 or that Americans went into debt to non-Americans by an additional $1.  Such a belief is popular, encouraged as it is by careless economic reporting.  But it is no more correct than is the belief that the earth is flat.  A $1 increase in America’s trade deficit might be evidence that Americans’ debt to foreigners rose by $1.  (Whether or not such an increase in debt to foreigners is a bad deal economically for Americans is a separate question: it might or it might not be.)  But a $1 increase in America’s trade deficit might very easily not mean that Americans have gone into an extra dollar’s worth of debt to non-Americans.

It’s child’s play to give examples of how America’s trade deficit can rise without Americans’ debt rising or Americans’ asset holdings falling.  And all children above the age of six should be able to follow these examples.  Here’s just one example: Valerie in Virginia buys $1 of shoelaces from Hans in Hamburg.  Hans adds his $1 to $999,999 of his German friends’ dollars that his friends (and now he) use to open a restaurant in Miami.  America’s trade deficit rises as result of Valerie’s purchase of foreign-made shoelaces.  Yet no American is any more deeply in debt as a result; this transaction hasn’t caused Americans’ debt to rise by as much as a single cent.  And no American’s (or Americans’) asset holdings are necessarily reduced by even a single cent.  The building for the restaurant, for example, might be leased from an American landlord – or, another possibility is that an American sells the land and building for the restaurant to the Germans and then that American invests the proceeds from the sale in stock he buys on the NYSE (and the stock appreciates afterward).