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Pittsburgh Tribune-Review: “Talk about the trade deficit”

In this August 18th, 2005, piece in the Pittsburgh Tribune-Review I talk about the so-called “trade deficit.” Beneath the fold you can read my ruminations.

Talk about the trade deficit

No concept in economics is as misunderstood as “trade deficits.” Most people who fret about this accounting artifact don’t even know what it is; they fret simply because the word “deficit” sounds menacing.

In fact, a trade deficit is generally nothing to worry about. And in the United States, it’s a boon.

But calming people’s anxieties about the so-called “trade deficit” is difficult because it is encrusted within layers of misunderstanding. Here are the beginnings of a conversation that I imagine myself having with someone (“Jones”) who is uninformed but open-minded:

Jones: Doesn’t America’s trade deficit scare you, Boudreaux? We can’t continue importing more than we export.

Boudreaux: I’m not at all scared. A trade deficit does not mean that we import more than we export. It means simply that we import more goods and services than we export of these things. But we pay for imports not only with goods and services but also with assets. If you count the assets that we export to foreigners along with the goods and services that we ship abroad, there’s no deficit — the value of what we export equals the value of what we import.

Jones: Whoa! Surely it’s harmful for Americans to pay for imports with assets. That’s like selling the farm to buy a few meals at a fancy restaurant — a little pleasure today but lots of pain tomorrow.

Boudreaux: Perhaps, but unlikely. Although they’re counted as an asset, dollars often are treated by foreigners as a service purchased from the U.S. Because the dollar is very stable compared to most other currencies, foreigners have a high demand for dollars to serve as a hedge against the fluctuating values of other currencies. In fact, people in some countries — such as Panama — actually use the dollar as their money. The more stable the dollar, the more intensely do people want to hold dollars as assets. And the higher this demand for dollars, the more willing are foreigners to sell us goods and services in exchange for dollars. In short, you can think of “stable money” as a service that Americans export to foreigners as partial payment for the things we import.

Jones: OK. But what about the other assets that Americans sell to foreigners?

Boudreaux: Even when Americans sell real estate or corporate stock to foreigners in exchange for foreign goods and services, there’s no need to worry. Foreign purchases of dollar-denominated assets mean that foreigners find the U.S. a good place to invest compared to the rest of the world.

I frequently ask my students if they’d be upset if someone would offer to invest in their future — say, by paying for their college education. They always answer “No!” And rightly so. So, too, with the U.S. economy. If foreigners seeking top return on their money look around the world, including in their own countries, and conclude that America is an unusually attractive place to invest, why should we worry if foreigners invest their dollars here instead of cashing these dollars out for goods and services?

Jones: We should worry because these investments aren’t being made by Americans!

Boudreaux: The number of investment opportunities isn’t fixed. When foreigners invest their dollars in dollar-denominated assets, such investments create wealth — they don’t stop Americans from investing.

Suppose Mr. Toyota is bullish on Microsoft, so he buys 100,000 shares of this American company. Several things happen. First, the American from whom he bought the shares now has a few million dollars on hand. This American might spend the money on goods and services, or he might invest it elsewhere — say, in his children’s education or in starting his own business.

Second, the value of Microsoft’s stock is bid up, making it easier for Microsoft to acquire capital for research and development, a new factory, whatever. These investments create jobs and enhance prosperity.

Third, over a longer period of time, depending on how wisely Microsoft conducts its business, the value of Microsoft stock will either continue to rise or it will fall. If it falls, the American profited while Mr. Toyota suffered a loss. If it rises, Mr. Toyota is rewarded for his foresight.

Jones: Yeah — and he, rather than an American, keeps the profits!

Boudreaux: So what• The profits are in dollars. If Mr. Toyota spends these profits on American-made products, he winds up buying more exports from America than he would have bought had he never invested here to begin with. And if he reinvests his profits, he creates even more capital for American workers to work with, further increasing their productivity and wages. Either way, Americans benefit.

To be continued ….