TCS Daily


Generosity, Trade Deficits, and China

By John E. Tamny - September 7, 2007 12:00 AM

In a column describing the appreciation of his Brooklyn (NY) brownstone, Portfolio Magazine economics writer John Cassidy said to his wife, "Thank God for the Chinese government. It made us a million dollars." To Cassidy's way of thinking, "generous lenders" from China and elsewhere have seemingly felt altruistic such that they've funneled their cash to the United States to bolster the prices of our assets. The latter assertion was one of many faulty ones in an article that furthered the false notions of low rates of saving in the U.S., "generous" foreign lenders, and the financing of trade "deficits" and "surpluses."

Cassidy partially attributed the heavy foreign capital inflows stateside to the alleged truth suggesting that as Americans don't save, "the U.S. doesn't have much savings to lend to anybody." Aside from the fact that our savings rate is very distorted, and cannot account for high returns on investment that drive our spending occasionally above the amount we earn, Cassidy's assumption about savings flies in the face of large anecdotal realities.

U.S. financial services firms regularly account for a large part of the S&P 500's total cap weighting, while mutual fund and stock-indexing firms such as Fidelity and Vanguard are some of the largest asset managers in the world. Investment firms of all shapes and sizes don't dot our economic landscape because we're poor savers, but because Americans are somewhat parsimonious as evidenced by the fact that U.S. household wealth is by far the highest in the world. High capital gains on investment as mentioned drive the official U.S. savings rate downward; the former a major reason foreigners are so eager to place their capital here to begin with.

Seeking to further explain heavy foreign investment in the U.S., Cassidy remarkably cited "generous lenders" based in China and Japan, along with Russian and Saudi Arabian governments flush with petrodollars. The problem there is that China doesn't so much buy dollars and dollar-denominated assets because it loves us, but because lacking a central bank with any experience when it comes to managing a major currency (the yuan), China's leaders have correctly deduced that despite our Fed's own monetary mistakes (including the inflation we're struggling with now), its own interests are best served by importing the currency expertise that our Federal Reserve currently offers. Large dollar reserves enable China to maintain a fairly tight peg to the world's reserve currency; one that makes its worldwide trade far more certain.

Cassidy points to Japan and China's large Treasury holdings as evidence that they somehow keep interest rates down in the U.S., but he fails to account for the regular churn that occurs with those same holdings. Indeed, as recently as 2005 total net Treasury purchases by China amounted to just $30 billion out of a $4.5 trillion Treasury market. Aside from the certainty that long-term inflation expectations impact U.S. interest rates more than demand, Cassidy's mention of foreign Treasury purchases is meaningless absent similar mention of sales over the same timeframe.

Turning to Russia and Saudi Arabia, Cassidy notes their large holdings of U.S. debt that are the result of them both being "flush with oil revenue." No doubt the latter is true, but with the U.S. by far the largest consumer of oil among countries, their dollar wealth is to a high degree the result of wealth generated right here.

The above speaks to the questionable worries expressed by Cassidy about our "chronic trade deficit," which to his way of thinking forces us "to borrow from abroad" to "pay for the difference between our import bill and our export revenue." In truth, it is a physical impossibility for the U.S. to have to finance its alleged deficits involving trade. All trade flows are financed when they cross the border. If foreigners choose not to finance their exports to the U.S., then the U.S. current account will necessarily decline. Just as I can't buy food if someone's not buying my labor, American consumers can't buy foreign goods unless someone, somewhere, has first purchased something of value from them. Trade, by definition, balances.

It can't be said enough that there is no such thing as trade deficits or surpluses. We're big buyers in Cassidy's words of "Lexus cars, Samsung cell phones, and all manner of Chinese products" because the rest of the world likes to buy our equities, land, intellectual property, and public/private debt. The alleged "deficit" has to do with investment not being factored into trade statistics, but sure enough we let the world make what's not in our economic interest to make so that we have time to build the most valuable companies in the world. Rather than spelling our future doom, the trade deficit is something we've had since the U.S.'s founding, and is a market signal that capital is treated best on these shores.

Cassidy's piece was correct in noting that the, "U.S. and China have a symbiotic relationship that neither side can afford to disrupt." He's absolutely right, but the relationship he speaks of isn't based on generosity, but instead results from the happy truth that the world economy is increasingly integrated in such a way that we're all dependent on each other for our economic health. That's a lucky development.

John Stuart Mill once wrote that free trade would make war less likely; meaning we should hope for more of, not less of the symbiosis he decries. In the end, the capital flows rooted in economic self-interest that he deems altruistic serve as the best insurance policies we have against future worldwide conflict.

John Tamny is editor of RealClearMarkets. He can be reached at jtamny@realclearmarkets.com

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3 Comments

generosity
It's kind of like how Adam Smith said the tinker, tailor, basket maker etc. are not making and tradeing to be generous, or because they are altruistic, but for their own benefit, with the result that everyone is better off. Such divisions of labour amognst individuals, also applies between states. But many people have the stupid notion that if one country gets richer, the trading parters must become poorer. Even the neighbours of red china, like Taiwan, Singapore, vietnam, are not getting poorer, but richer.

Socialist are afraid?
Maybe the socialists are afraid free trade will destroy the socialist countries like China.

A promise to pay
The author's thesis is as follows:

"Just as I can't buy food if someone's not buying my labor, American consumers can't buy foreign goods unless someone, somewhere, has first purchased something of value from them. Trade, by definition, balances."

Nonsense. If no one's buying his product he can borrow the money. Which is what the US government does by indulging in deficit financing, and the US economy does whenever there's a negative balance of trade.

"It can't be said enough that there is no such thing as trade deficits or surpluses. We're big buyers in Cassidy's words of "Lexus cars, Samsung cell phones, and all manner of Chinese products" because the rest of the world likes to buy our equities, land, intellectual property, and public/private debt."

When someone exchanges an object of value for a printed banknote he assumes it can also be exchanged for some other thing, of like value to the product he traded. If instead he finds he is just funding the continuance of some intractable (and ever widening) deficit, he is likely in time to feel he's getting a bad deal.

That feeling manifests itself in the devaluation of the banknote, which over time buys less and less. Many economists feel this is not a wise policy to pursue indefinitely. But what do they know?

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