Here’s a letter to regular Cafe Hayek reader Chris Gengaro; Mr. Gengaro is trying to convince his friends to reject protectionist fallacies:
Thanks for your e-mail.
“My argument with my friends continues. They are of the view that:
(1) Not all dollars return to the US. Instead, foreigners invest many of those dollars in stocks and bonds. When someone buys stock, those funds don’t go to the company (other than the initial IPO). So how, in this instance, are the dollars invested in the US? Same with bonds. They are just traded on markets after the initial offering. So, again, no funds go to the Company.
(2) What Trump is doing is called negotiating.”
Let me here deal with (1); I’ll deal with (2) in a later letter.
First, even when foreigners use their dollars to buy corporate shares on exchanges or to buy bonds on secondary markets, they are investing in dollar-denominated assets the values of which depend on the health of the American economy. These investments reveal a confidence in the American economy that should please us Americans.
Second, while dollars spent to purchase stocks and bonds on secondary markets don’t go directly to the companies or other entities that issued the stocks and bonds, these companies and entities nevertheless benefit from these purchases. Secondary-market purchases of a corporation’s shares increase the price of these shares and, thus, increase that corporation’s market capitalization. That corporation’s ability to raise capital, either through the issuance of new shares or through credit markets, is enhanced. Similarly, the more intense the secondary-market demand for U.S. government bonds, the higher is the price of these bonds and the lower is the interest rate that American taxpayers pay on Uncle Sam’s debt. Americans taxpayers thus have more money to spend on goods, services, and assets other than debt servicing.
Third, dollars spent by foreigners to buy stocks and bonds on secondary markets are received as income from the sellers of these stocks and bonds. These sellers now have more dollars either to spend or to invest. From the perspective of an American firm, it makes no difference if its sales of software or of sausages increase because foreigners directly buy more of that firm’s outputs, or because foreigners’ purchases of financial assets on secondary markets enable Americans to buy more of that firm’s outputs.
I hope the above helps.
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