… is from page 50 of the 2002 first edition of Geoffrey E. Wood’s Fifty Economic Fallacies Exposed [original emphasis]:
If a country is borrowing abroad, it is not necessarily increasing net overseas indebtedness. That may seem surprising – if a person borrows, his or her debts increase. But even in that case, if he or she has assets, they may be increasing in value more rapidly than the new debts.
DBx: Yep.
Even for that portion of a country’s trade deficit that consists of foreigners’ lending money to residents of the home country – that is, for that portion of a country’s trade deficit that is actual debt – there is no implication that that portion of the trade deficit either is evidence of, or a source of, economic troubles in the home country. There are many economically sound reasons for borrowing money, one of which is to enable businesses to acquire funds, at the lowest possible cost, to expand or to otherwise improve their operations. Successful use of such borrowed funds increases the real net worth of the borrowing businesses.
Of course, excessive borrowing – by households or businesses – is possible, and it does sometimes occur. But there are strong natural checks on such borrowing: Not only do households and businesses themselves have strong incentives to avoid excessive borrowing, lenders have strong incentives to avoid lending to individuals and businesses that are over-extended in their financial obligations.
The big exception to the rule that there’s no reason to worry much about excessive borrowing is supplied by governments (especially those with access to their own central banks). Political incentives encourage existing governments to borrow excessively; they do so because the benefits of government spending today are enjoyed by today’s citizens-taxpayers while the burden of paying for this current spending is loaded onto future citizens-taxpayers, many of whom aren’t yet even born.
Yet even in this case, to the extent that the home-country government borrows from foreigners, the problem isn’t the resulting increase in the home-country’s trade deficit (or shrinkage in its trade surplus); the problem is the excessive spending. The cure for this ailment is to rein in spending (perhaps with a strong balanced-budget constraint) rather than to point to the red-herring of the rising trade deficit as if the cause of today’s excessive spending and growing indebtedness is foreigners’ willingness to lend.
