TCS Daily


Stop Worrying About the Trade Deficit

By Donald Boudreaux - February 10, 2006 12:00 AM

America's trade deficit -- in December reaching a near-record $64.7 billion -- is unfortunate, right?

Wrong. Contrary to popular opinion, this so-called "deficit" is a blessing.

Consider that if Americans export lumber, sheetrock, and architectural blueprints to China so that people build a factory there, we're gleeful. "Wonderful!" we proclaim. "Exports are up and our trade deficit is down!"

But if those very same building materials are assembled by Americans into a factory situated and operated in, say, Utah and then bought by Chinese investors, we complain -- led today by the likes of Senators Charles Schumer and Lindsey Graham -- that "Something's wrong! Our trade deficit is higher!"

Truth is, though, that nothing economically important separates the first scenario from the second. In each case the world's stock of productive capital grows as Americans produce things for sale to foreigners. Those cases appear different from each other only because of the conventions of international commercial accounting, which records investments separately from imports and exports.

This accounting convention creates the false impression that an excess of imports over exports -- called a "trade deficit" -- is an ominous imbalance requiring corrective action. In fact, America's trade deficit is evidence, not of any imbalance, but of the happy fact that our economy is so strong and stable that foreigners invest here eagerly.

When foreigners sell things to Americans they earn dollars. If foreigners then spend all of those dollars on American exports, trade is "balanced." There's no trade deficit or surplus. But if foreigners instead invest some of those dollars in dollar-denominated assets -- say, by purchasing that factory in Utah, houses in Hawaii, or shares of Google -- they obviously must buy fewer American exports. So the trade deficit grows as investment in the U.S. rises.

Although dollars spent by foreigners on investments are not spent on items classified as U.S. exports, these dollars nevertheless are spent in the U.S. They raise the value of American corporations and real-estate, and improve American workers' productivity. In turn, those increases in asset values and productivity enhance Americans' current ability to buy goods and services -- perhaps the same goods and services that foreigners would have bought had they not invested their dollars here.

Isn't it better, though, if Americans do the investing and foreigners the consuming? No. What's important is to have lots of investment to increase worker productivity, which ultimately is the only way to raise our living standards. The nationality of investors is insignificant.

Because savings and investment are indeed so beneficial, we should welcome rather than regret foreign savings invested in our country. If we applaud the guy across the street who forgoes that vacation in Las Vegas in order to save and invest more in the U.S. economy, we should applaud also the guy across the ocean who does the same.

But doesn't a higher trade deficit mean that Americans are sinking more deeply into debt? Not at all. A trade deficit isn't debt. My young son, for example, received for Christmas several Chinese-made toys. These were bought with cash. If the Chinese toymakers invest their newly earned dollars in, say, that factory in Utah, the U.S. trade deficit rises but no debt is created. Neither I nor any other American owes any foreigner anything as a result of my purchase of toys from China and the corresponding Chinese purchase of equity in a company located in America.

More generally, whenever foreigners buy American real-estate or equity, or when they simply hold dollars in their portfolios, our trade deficit rises without creating debt.

Nor is it true that a higher trade deficit means that Americans are selling off assets. Whenever, for example, IKEA builds a new store in the U.S., a new asset is created. No Americans had to part with assets as a pre-condition for this Swedish investment in America.

Of course, part or all of the trade deficit can become debt. This happens whenever Americans borrow dollars from foreigners. As it happens, the most prodigious borrower today is Uncle Sam. But despite self-righteous accusations leveled at foreigners by the likes of Senators Schumer and Graham, the fact remains that U.S. government indebtedness is not caused by foreigners buying Uncle Sam's bonds, but by Congress spending beyond its means. If government debt is a problem, then Congress should stop borrowing. Complaints about the trade deficit are a red herring.

We Americans have many real problems confronting us. The trade deficit isn't one of them.

The author is Chairman, Department of Economics, George Mason University.

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19 Comments

Trade Deficit
Isn't it strange how some economists think that the trade deficit doesn't matter and others think it is a sign of impeding economic collapse?

What other "science" has leading practitioners coming to opposite conclusions from the same data?

What happens to the US economy if the foreign central banks now investing in treasury bonds start to put their money elsewhere? I think a paper which claims that the present situation does not present a risk should be extended to cover scenarios such as this.

We have seen situations in many other countries where the appeal of their currency has diminished and the economic impact this had internally. If it is to be assumed that the US is in such a strong position in the world economy that this is not a realistic threat then the reasoning for this should be given as well.

The UK thought it was in a strong enough position to resist currency adjustment and George Soros made a lot of money proving them wrong.

Trade Deficit is a vestage of the Steam Era
The trade balance statistic is a dangerously misleading legacy from the Steam Era- when commerce consisted only of exporting or importing things that came in crates and sailed on ships.

It does not and, as presently structured, cannot take into account the sale of goods that aren't shipped in crates.

As any user of Google can find out in less than 0.32 seconds, every export must be accompanied with the filing of a SED (Shipper's Export Declaration), a form that is used by the US Census Bureau to compile trade statistics.

When Boeing sells a $5 million jet engine to Japan, that number goes towards the trade balance statistic.

When Oracle sell $5 million worth of software to Japan, since nothing tangible was exported, there is no SED, and there is no accounting in trade balance statistic.

When Pixar ships the master print of Finding Nemo to Japan, for which it will earn several million in royalties, the value of the film in the can ($1,000?), not the expected amount of royalties is the amount declared on the SED.

So, apart from every valid point this article makes about the Trade Deficit, the very basis for the statistic which everyone seems transfixed by, is bogus in an economy that has a high percentage of its trade in the export of ideas and intellectual property such as music, media, license fees and software.

Worse, we have taxation, regulation and public policy being decided on the basis of fixing what is unfixable nonsense. Such repairs more often than not do more damage than anything.

Red Herrings
Congress needs to place the blame for their excess spending upon something.

What are exports?
Why does not macroeconomics include in exports financial instruments? If this were included, then perhaps there would be no "deficit." Seems like there is a definitional problem here.

ABD

currency movements
If foreign banks pull their investments out of the US, what are they going to do with them? Unless they stick their money in a mattress (a really big mattress), they are going to have to invest that money somewhere else.

What happens to that somewhere else? Since there is now more money going into that somewhere else, returns start dropping. (Basic supply and demand) So what happens when returns start dropping. Some of the investors pull out and start looking for happier hunting grounds. Much of that money that gets pulled out will find it's way to the US, since returns have come up a bit here, because the first country pulled out.

Net result. Not much.
A reshuffling of who is investing where, but total investments don't change much.

Much of Britain's and Indonesia's problems came about because they tried to fix their exchange rates, instead of letting them float.

exports
The export numbers also include seperate categories for goods and services.

Most prognosticators still focus only on the "goods" number. Even though the US is becoming more and more a services economy.

exactly
The good thing is that red herrings can't stand up for themselves or talk back and are therefore ever-ready scapegoats!

all my life
I can't remember a time since I became politically aware in the 80's when we did not have a "trade deficit." Does anyone know if there was a surplus in the last 25 or so years?

So far, there doesn't appear to be any bad fallout. It's like global warming. A lot of people say that "everybody" agrees it's a bad thing, and I should be worrying about it night and day, yet every day, the sun rises and, life goes on much the same as before.

The trade deficit is an effect not a cause of economic problems.
As long as the government has run a budget deficit and the Fed devalues the currency, the US will have chronic trade deficits. Prior to the Federal Reserve, the US had periods of high trade deficits and low trade deficits. In other words, consumers purchased foreign goods with gold until the value of the gold began to rise. At that point they stopped buying foreign goods and focused on American goods while the foreigners with an excess of gold would begin buying American stuff.

My ultimate proof of stupidity of the trade deficit concept is that if we were really interested in reducing the trade deficit then we would eliminate the federal budget deficit and stop devaluing the currency. When we had a balanced federal budget and the highest value currency in the world we had less of a trade deficit.

Services are included...
Service exports are declining as a trend.

Don't worry, be happy
First, Glassman disses Bush for making the "addicted to oil" comment, arguably the most honest thing Bush has ever said. TCS articles regularly proclaim how healthy the US economy is. Now another TCS "contributor" weighs in on the trade deficit and conveniently overlooks the single biggest contributor to the record trade deficit. You guessed it - OIL.

Not a single mention of imported oil in the record trade deficit. Uncanny.

accuracy
It's only accurate in the sense that we are also addicted to food, water, and air.

accuracy is still accuracy...
Food, water and air are essential to sustain life, oil is not. No, Bush's phrase was spot-on accurate even if it was only lip-service. It's accurate because civilization flourished long before oil was discovered. And it may again flourish once humankind has recovered from consuming its one-time allotment of oil. We've already seen what small spikes in supply/demand do to gasoline prices. Without cheap oil, the US economy will seize up like a Hummer with an empty crankcase on the interstate.

The knee-jerk freemarketeers are cutting off their collective nose to spite their face on the oil issue.

Gimme a break
DT,

You posted:

"It's accurate because civilization flourished long before oil was discovered"

This is true as far as it goes but don't romaticize the past. If we have become addicted to something it is cheap (relative to the value of what we make with it), abundant energy on demand. What this has brought us is long lives of relative comfort and material well being (for those free to pursue it). Copious amounts of nat gas, coal and oil are used to produce energy because of their high specific energy content and low cost of procurement. Energy is the thing, not oil. Nobody will care whether it is fossil fuel, wind, solar, tidal, hydroelectric or nuclear that provides it as long as it is cheap, abundant and available on demand.

Here's your break
No one's romanticizing the past. The "addiction" metaphor, like any metaphor, will break down when taken to its illogical extreme. But its the most apt description yet of America's relation to fossil fuel, and it's noteworthy because it came from a poster boy for Big Oil.

"food, water, and air" are not addictions in the literal sense of the word. They are essential for life. Oil and other hydrocarbons are indeed cheap and abundant sources of energy, but they are NOT essesntial to human life like food, water, and air.

Depriving the American economy of cheap imported oil would be much like depriving an otherwise functional heroin addict of his drug - severe withdrawal pains. And the United States consumes 25% of the world's oil while producing only 4 or 5%. And US oil production peaked in the 70s. OPEC is growing the opium poppies and Big Oil is our dealer. So in this respect, Bush's statement was remarkably honest for someone who is known for corny platitudes and equivocation.

And even more remarkable is TCS's refusal to acknowledge this addiction to imported oil in an article about trade deficits. How much money does TCS get from Big Oil, anyway?

Think again
DT,

Food is stored energy, oxygen is needed to release it and water is the medium in which the conversion takes place. Life, at is core, is the exploitation of energy sources. Abundant life requires abundant energy. Life before abundant energy sources (and distribution thereof) became available was lived pretty close to the bone. You know, nasty, brutish and short.

Imported oil is the lion's share of the trade deficit...
...and yet, strangely enough, there was no mention of that in the article we're commenting upon. It hasn't always been that way. The US used to be a net exporter of energy. No longer. Like an addict, we consue far more energy than we produce, and we have the trade deficit to prove that.

Everything you say about energy is basically true, but the era of cheap, abundant energy is coming to an end and the US is not remotely prepared to wean itself off its addiction to imported oil. Life in this country will once again become nasty, brutish and short if this addiction is not acknowledged and alternative energy sources are not brought online.

Not mentioned...
because the commodity being imported is irrelevant to the discussion. You seem to have missed that point.

I find your lunatic ramblings about the sky falling highly amusing. I look forward to enjoying them even more twenty years from now, driving my SUV and using even more energy than I do now. You guys are nothing but false prophets, with a seemingly compulsive need to lecture others about their supposed faults. We use energy to build the world, a world with less disease, less hunger, less war, and longer life. Scolds accomplish nothing. The world is dynamic, and changes by the minute, but the doom sayers never change. They are also never correct.

Bush says we're addicted...
...and the arm-chair free-marketeers at TCS are apoplectic. Oil is irrelevant to the discussion of the trade deficit? Keep fiddling, Nero.

And talk about "amusing." Your "less war" line is a real knee-slapper. And TCS's raison d'etre is to "lecture others about their 'supposed' faults." Speaking of faults, ask your mentor Mr. Glassman when the market will hit 36,000.

Maybe you should buy a clue to go with your new Hummer.

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