Here’s another letter to my regular correspondent Nolan McKinney:
You’re correct that some economists insist that America’s trade deficit must be “repaid.” These economists are mistaken. Only that part of the U.S. trade deficit that is loaned to Americans must be repaid. No other part of the U.S. trade deficit – not foreigners’ holdings of dollars, not foreigners’ investments in equity, not foreigners’ purchases of real-estate – must be repaid.
First consider foreigners holding dollars. It’s true that foreigners who own dollars thereby have the ability to purchase goods and services made in America. But this ability of foreigners to buy American-made outputs is in no meaningful sense American “debt.” You yourself – a self-described “trade deficit hawk” – positively cheer when foreigners immediately spend their dollars on buying exports from Americans. You cheer because such an immediate expenditure of dollars does not increase America’s trade deficit. But note that this immediate expenditure does indeed involve foreigners laying claim to some American-made goods and services. If we Americans suffer no worrisome loss of goods and services whenever foreigners today cash in their justly earned claims to American-made outputs, how is it that we suffer such a worrisome loss of goods and services if foreigners wait until tomorrow to cash in their justly earned claims?
Now consider foreigners purchasing ownership stakes in American-based business (or in real estate located in America). Suppose that Mr. Lee from China uses 20 million of his dollars to launch a business in Alabama producing chocolate-covered anchovies. This use of dollars increases America’s trade deficit by $20 million. A couple of years later Mr. Lee concludes that, contrary to his expectations, too few consumers want to buy chocolate-covered anchovies. He declares bankruptcy and loses his entire investment. No American has then, or ever, to repay Mr. Lee one cent of the $20 million that Mr. Lee invested and lost in this American-based business. (If, on the contrary, Mr. Lee’s business should prove to be profitable, any value that Mr. Lee takes ‘out’ of the American economy as profits is at least matched in amount by the value that his creative entrepreneurship, risk-taking, and work injected into the American economy through his successful American-based business.)
It is simply incorrect to insist that a trade deficit represents an obligation to foreigners that must be repaid in the future.
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