Here’s a letter to a Facebook friend.
Greg:
Thanks for your e-mail.
Your correspondent commits the commonplace mistake of assuming that any increase in the U.S. trade deficit necessarily means that Americans are going further into debt to – or selling off assets to – foreigners. Evidence sufficient to refute your correspondent’s claim is the fact that the average real net worth of the American household is today more than triple what it was when America last ran, in 1975, an annual trade surplus. (So too, by the way, is the real net worth of the median U.S. household higher than it was in 1975.)
But if your correspondent doesn’t trust the data, here’s a simple hypothetical example that proves that U.S. trade deficits can increase without Americans going further into debt or reducing their net asset holdings.
In Year 1 Americans import $10,000,000 worth of stuff and export $10,000,000 worth of stuff. These are the only international commercial transactions that occur in Year 1. In Year 1, therefore, America has no trade deficit or surplus. Protectionists are happy.
In Year 2, Americans again import $10,000,000 worth of stuff, but foreigners – having become keen on investing in America – buy only $6,000,000 worth of stuff from America. In Year 2, because America imports $10,000,000 but exports only $6,000,000, she runs a trade deficit of $4,000,000. Protectionists are now unhappy.
The $4,000,000 that foreigners in Year 2 don’t spend on American exports is instead invested by foreigners in America. Let’s say that foreigners use this $4,000,000 to buy land in Texas on which they build a factory. They pay cash for the land. The American seller of the land then uses the $4,000,000 he receives for the sale of his land to start a business in Houston, which turns out to be profitable.
Although in Year 2 America runs a trade deficit, where’s the increased American indebtedness? Where’s the net loss of assets? Nowhere! Quite the opposite; Americans’ real net worth has increased.
Although this example is hypothetical, nothing about its essentials is unrealistic. It proves that U.S. trade deficits do not necessarily mean that we Americans are going further into debt to foreigners or that we are net sellers of assets to foreigners.
And because the real net worth of the average American household is today more than triple what it was in 1975, this hypothetical example helps explain factual reality. That reality, again, is that – despite the appalling fiscal incontinence of the U.S. government and foreigners’ purchase of some of this government debt – America’s half-century-long run of annual trade deficits have not turned Americans into indebted paupers, which would have been the outcome if U.S. trade deficits necessarily mean that Americans go further into debt or are net sellers of assets.
Sincerely,
Donald J. Boudreaux
Professor of Economics
and
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030
