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I Repeat Myself

Here’s a letter to someone who is skeptical of my and Phil Gramm’s support for free trade.

Mr. G__:

Thanks for your thoughtful response to my and Phil Gramm’s criticisms of Trump’s protectionism.

You say that we “ignore that with every year of trade deficit Americans go deeper into debt to foreigners.  Robert Lighthizer points out that this must end in ruin.  I think he is right.”

With respect, it’s simply untrue that Americans’ indebtedness to foreigners necessarily increases whenever America runs a trade deficit. Here’s a simple example. Suppose that in July Americans import $1 million of goods from abroad and in that same month foreigners spend every cent of that $1 million buying American exports. There’s no trade deficit in July. Now Suppose that in August Americans again import $1 million of goods from abroad but foreigners then hold all of this $1 million as cash reserves until sometime next year. In August America runs a $1 million trade deficit.

Yet in this situation there’s no resulting American indebtedness to foreigners. No American incurs an obligation to repay any debt to non-Americans. The same is true if foreigners in August use the $1M to buy, say, condominiums in Colorado. Foreigners now have housing in Colorado, American condo-sellers have $1M more in cash, and no debt was created in the process. And ditto if foreigners invest the $1M in dollar-denominated equity. Only if and to the extent Americans voluntarily borrow dollars from foreigners do Americans incur debt obligations to foreigners.

Unlike a household or a government running budget deficits year after year after year – which does increase that household’s or government’s indebtedness to others (or reduce that entity’s net worth) – a national economy running trade deficits, even over the course of decades or centuries, does not necessarily increase the indebtedness (or decrease the net worth) of that nation’s citizens. Unlike a household, firm, or government, an economy is not an organization with a legal identity that gives it standing to make claims against other entities or to be held liable for claims made by other entities. As such, a national economy has no meaningful balance sheet. Never-ending confusion is caused by the unfortunate practice of grafting accounting concepts designed for households and organizations onto that vast, undesigned complex of individual interactions that we call “the American economy.”

The above, I’m aware, is abstract. So let me end with this fact. America last ran an annual trade surplus in 1975, the year I entered my senior year of high school. This year I turned 65 – the conventional retirement age. If, as Mr. Lighthizer insists, American trade deficits drain Americans of net worth, we surely would be much poorer today as a result of America having run annual trade deficits for my entire and now-long adult life. Yet in fact the real net worth of nonfinancial corporate businesses in the US is today 354 percent higher than it was in 1975, and the real net worth of American households hit an all-time high in the first quarter of 2022 and is today very near that high. These facts are practically impossible to square with Mr. Lighthizer’s insistence that American trade deficits necessarily drain wealth from our shores and people.

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

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