The Hidden Danger of Trade Deficits
Trade deficits indeed present no problem as long as they get financed, writes Antony Mueller. What will happen, however, when the United States is forced to reduce the deficit and needs to obtain surpluses in its foreign trade? The problem is not the trade deficit per se but how to get rid of it when foreign financing stops. FULL ARTICLE
Comments (46)
I think Prof Mueller should read Bastiat again. Part of the problem with his analysis of the trade deficit lies in the illusion of money that Bastiat argued against. To summarize poorly, the money illusion says that money is wealth, but as Bastiat wrote, it’s not. Goods equal wealth. Money is just a medium of exchange between labor and goods. The proper attitude is that the US becomes wealthier via imports. The exporter nations become poorer because they are stuck holding paper instead of wealth. At some time in the future we will exchange that paper with even more worthless paper. For confirmation, look at the wealth of most exporters and you’ll find that they are very poor countries, including most oil exporters. Even Europe and Japan are growing poorer in relation to the US in spite of their enormous exports.
The standard models of trade, including Mueller’s, are based on the business exchange model. In this model, businesses must sell more than they buy or they will go bankrupt. Borrowing can only stall the inevitable. But this model implies that the source of our wealth is trade. It’s not. The source of US wealth is productivity brought about by the division of labor and increased investment.
The correct model for international trade is the household. For example, my household has a huge trade deficit with Wal-Mart, the mortgage company, the utility company and others. None of those entities ever purchases a thing from me, but about 90% of my income goes to them. Why am I not bankrupt? Because I earn my money as an analyst for a healthcare company, not in trading with Wal-Mart. I buy food and clothes from Wal-Mart because I can buy them cheaper than I can make them myself. If I tried to make everything I buy from Wal-Mart, and achieve self-sufficiency, I would have to quit my day job and would become very poor.
The US imports primarily consumer goods and oil because other countries can produce them cheaper than we can. Therefore we become richer by importing them. As for borrowing the money to do so, I have never borrowed money from a foreign country. Two groups borrow foreign money—businesses and the federal government. I don’t have to worry about businesses repaying their loans; they’ll do that out of profits or go under. Government borrowing is another matter; I am responsible for repaying part of that and so are my children. But then government borrowing is a problem without a trade deficit and the issue we should be concerned with.
Published: April 12, 2006 10:07 AM
Roger, I think you're missing the point.
As I understand it,Mueller's point is "what happens when they stop accepting our illusory, worthless paper in exchange for their goods?"
As Mueller points out, it will be painful for them (the creditors), as they will hold a lot of worthless paper. But those will be sunk costs, and sooner or later they'll accept that fact, and realize the folly of throwing good value after bad. The problem will be that it will be much more painful for the debtor, who will have no productive capacity to produce goods other people find worth trading for.
Published: April 12, 2006 10:56 AM
I was trying to expand the discussion beyond just the trade equations and look at it from a different perspective. From Bastiat’s POV, the trade figures should be totally, utterly uninteresting to us. So more to Prof Mueller’s point, he writes that we are borrowing from foreigners in order to finance our consumption, but no consumer borrows from a foreigner government. Only large businesses and the government borrow from foreigners. Foreigners will continue to lend to both as long as they’re credit worthy and the lenders can’t find a better place to put their money.
If all foreigners refuse to loan to all US businesses, US interest rates would rise. Big deal! Then Americans would start to save more. But that won’t happen. They’ll accept some and refuse some as they do now.
If the US government loses creditworthiness, the whole world is in trouble. At that point, we begin studying St. John’s Revelation for signs of the end times. It’ll make the Asian financial crisis sound like a rabbit fart! But we need to worry about federal borrowing for other reasons as well: It increases taxation, the size of government and the temptation to inflate our way out of it.
As for the structure of US manufacturing changing because of the trade deficit, I don’t see it. The American Institute for Economic Research just published an article of mine on manufacturing in the US. Here’s a summary:
The manufacturing sector of the US is the largest in the world. It’s almost as large as all of China’s economy put together. By itself, the manufacturing sector would make up the 7th largest economy in the world. But we don’t make consumer goods; we make producer goods. The reality is just the opposite of what Prof Mueller writes. We buy consumers goods overseas because places like China have a competitive advantage in labor. Purchasing consumer goods from the Chinese makes us richer because they can make them cheaper than we can. Manufacturing is shrinking as a percentage of our economy because we are becoming wealthier and purchasing more services, not because manufacturing is dying. In fact, we just recently hit an all time high in manufacturing output in inflation adjusted dollars.
Published: April 12, 2006 11:54 AM
PS, Most of the talk about trade suffers from collapsing time. We don't borrow money to pay for imports. We pay cash. Later the foreigners decide whether to spend the cash or save it. Either way, someone eventually uses those dollars to buy US securities. If you eliminate time, it appears that we are borrowing to pay for imports, but we're not. If US securities become unattractive, interest and exchange rates will adjust to make them more attractive. That's all that will happen!
Published: April 12, 2006 12:40 PM
"but no consumer borrows from a foreigner government."
Ah, but I think that was exactly Mueller's point - currently, retail banking is making a larger and larger part of our banking. And the loans people are taking out are being borrowed from foreign sources, whether it is through Fed manipulations or through the sale of private securities. These loans are powering current consumption and demand.
"the lenders can’t find a better place to put their money. "
Again, this is the point, as I read it. Sooner or later, some of these foreigners are going to recognize that they're losing out in this transaction, and that it's not going to turn around, ever. So they'll start looking for commodities, like gold and oil, to put invest their savings in. Hmmm. How are the prices of those two commodities doing these days?
"US interest rates would rise. Big deal!"
Hmm. Not sure I can agree with that assessment when our economy is heavily leveraged by consumer borrowing. Maybe. But to blithely assume that there's no possible danger reminds of the mindset of the late 1920's.
"If US securities become unattractive, interest and exchange rates will adjust to make them more attractive. That's all that will happen!"
Yes, Greenspan and Bernanke have slain the inflation dragon. Pay no attention to the man behind the curtain!
Published: April 12, 2006 1:57 PM
Come on folks. Somebody please prove Roger M wrong. I need to know if there's a natural check on the process, or if the US hegemon is here to stay.
Published: April 12, 2006 2:13 PM
As they say, anything that can't go on forever, won't. Since an economy can only borrow and spend, rather than save and produce, for so long, the US economy is doomed.
Here are three of a growing number of articles on the subject:
http://www.vheadline.com/readnews.asp?id=53514
http://www.lewrockwell.com/douglas/douglas9.html
http://www.energybulletin.net/12125.html
Published: April 12, 2006 3:17 PM
Reactionary, nothing lasts forever. The American Empire is doomed, it always was. The only questions are "when" and "how".
"When" is easily answered, it will be when the citizens repeal their consent en masse.
"How" will be more interesting. The only thing that seems certain is that no government has given up power willingly, nor have laws once in place been repealed (in bulk) without a complete disintegration of the system into petty states.
On the other hand, a return to the "City State" structure, in my opinion, would be an improvement on the "Nation State" that exists now. Such a dissolution might even be accomplished without too much bloodshed. But in contrast to my rosy opinion is what actually happened the last time someone tried to secede from the "United" States.
Published: April 12, 2006 3:39 PM
Guys, read Bastiat! We should not pay attention to trade data at all.
Inflation is a big problem, but not for trade. It destroys the wealth of little people who don't know how to protect themselves against it. In trade, it makes paying back loans much easier later on. Look at 10-yr rates--4.5%! At that rate, foreigners are barely covering inflation. They're loaning us their money for nothing!
Inflation may spur consumption on durable goods, because people borrow to buy them, but again, we don't borrow directly from foreigners. We borrow from banks, who may borrow from foreigners. The foreigners have the dollars to lend because we purchased goods from them months earlier. The decision to loan dollars to an American bank for relending has nothing to do with our rate of consumption, but on the credit worthiness of the borrowing bank.
Without federal borrowing, the only people in trouble would be businesses that borrow from foreigners. If their creditworthiness falls, they will have to pay more for loans, just as GM does since its credit rating fell to junk level. If this happens to all businesses in the US, interest rates will rise and fx will fall enough to attrack foreign money back. But it will be gradual, unless there's an international conspiracy I don't know about.
Federal borrowing is a different matter. Eventually, the credit rating of the federal government could fall and cause its borrowing costs to go up. More of the budget would go to paying interest. Eventually, all of the budget could go toward paying interest. It's a real threat.
The whole idea that there's danger lurking in the trade deficit somewhere is partly due to the money illusion problem and partly to plain old mercantile thinking.
Published: April 12, 2006 3:44 PM
PS, I would add that our current trade deficit isn't large enough! We need to lower barriers to clothing and food and buy more from Mexico and China. That would reduce the cost of living in the US dramatically, allow Mexican workers to stay home, and make us richer!
Published: April 12, 2006 3:46 PM
PS, Our current trade deficit is too small! We need to lower barriers to clothing and food and buy more from Mexico and China. That would reduce the cost of living in the US dramatically, allow Mexican workers to stay home, and make us richer!
Published: April 12, 2006 3:47 PM
Bastiat never supported printing money (or creating it via book keeping tricks) in order to finance consumption spending (or any other spending come to that).
True enough, even if there was no trade deficit at all the money supply expansion would still lead to a boom-bust, but the trade deficit is a warning sign (just as the real estate bubble is another).
As for the trade deficit itself it is not as if people were mostly buying capital goods (machine tools and other such) - it is consumption spending, financed by the credit-money bubble.
People (like the Cato Institute) who think this can go on and on are deluding themselves.
Of course the government is also borrowing money hand over fist (both openly and "off budget"). This is not just to finance the various wars, but (and more importantly over the long term) to finance the ever greater burder of the "entitlement programs" (Medicare, Medicaid and all the rest of them).
This unconstitutional spending orgy is going to crash eventually - and even Social Security will go.
Published: April 12, 2006 4:04 PM
Paul,
No Bastiat didn't support printing money.
With regard to inflation, the issue its effect on trade. The primary cause of the trade deficit is our wealth. The world is our Wal-Mart and we like to buy pretty things. Inflation can boost spending on imports, but it's not the major cause.
If the fed suddenly stopped printing, interest rates would rise, consumers would quit borrowing for awhile, and imports would slow. Does anyone think that hasn't happened before? Remember the early 1980's? (Some of you are too young.) Why the panic now?
Lenders don't just get tired of lending; they're not running a marathon. Investors choose to lend elsewhere because they have found a better deal. Where in the world will they find a better deal than the US? If a miracle happens and some other country learns how to do capitalism, then investors will take their money out of the US and lend it to the new miracle economy. At the first sign of reluctance to loan money to US companies or the government, interest rates will rise and fx will fall. What's so scary about that?
Published: April 12, 2006 4:43 PM
My father tells me that in the 1950's there were people who had been predicting the collapse of the dollar since the 1920's. I also find it significant that not a single modern currency crisis has spurred a move into commodity money.
The Fed and the Treasury have made it pretty clear that if we need more money we'll just print it and dollar holders haven't even blinked. Mass immigration will continue to expand the tax base and there's all those Western lands and mineral rights the government can draw on.
I'm afraid the game will continue for an awfully long time.
Published: April 12, 2006 4:50 PM
I'd say that a currency that has lost over 95% of its value in less than a century (actually, since FDR's gold confiscation in 1933) is the very definition of collapse, never mind that the American sheeple are clueless about it.
Let's be clear here: Roger M and Reactionary espouse state plunder and are only too happy to see it continue.
Published: April 12, 2006 5:15 PM
"Only large businesses and the government borrow from foreigners."
The large businesses in the USofA are mostly foreigners - will be for sure if GMC tanks. Will our foreign owners let their economic interests in the USofA collapse?
"Inflation is a big problem, but not for trade. It destroys the wealth of little people who don't know how to protect themselves against it."
Inflation hurts the coupon clippers and helps the working people who have large mortgages. Nothing is going to help the half of credit card holders who owe an average $8,000 balance or buy new cars "upside down." They should be our poverty class but transfer payments from the more intelligent portion of the working class keep them afloat.
"The American Empire is doomed, it always was." Someone else who understands that the U.S. economy since WW2 is freak economic conditions which will never return in our lifetimes? We are sliding back to prewar conditions with a very small middle class and most of the working people on the edge of poverty.
"On the other hand, a return to the "City State" structure . . . ." If not for the electoral college, the USofA would be controlled by NYC, Chicago, Los Angeles, Houston/Ft Worth, and Dallas.
"If the fed suddenly stopped printing, interest rates would rise, consumers would quit borrowing for awhile, and imports would slow."
I suspect what the fed prints is piddling compared to what the consumers print with credit cards.
Published: April 12, 2006 7:54 PM
We in the US are up against two big problems: government inflation, and government spending. The trade deficit is a problem only to the extent that the above two problems make it a problem and I question the extent to which they in fact do make it a problem at all. In any event, in an unhampered market, a trade deficit is great.
So, here is my view: the solution to the trade deficit “problem� to the extent that it is a problem, is elimination of government inflation and spending.
Further, I’d like to suggest that the trade deficit we have with the Chinese, for example, is a result of the Chinese government’s policies more than our own government’s. I say this because the natural result of domestic inflation, all other things remaining equal, is a quick depreciation of the dollar on the foreign exchange markets. This results in higher costs for imports to the US, resulting in a very quick curtailment to imports back to their natural level. Therefore, I don’t think excessive domestic inflation can cause sustained trade deficits.
On the other hand, a foreign government’s central bank’s monetary policy can certainly influence the situation if it intentionally undervalues their currency just for this purpose. In doing this, they essentially subsidize their exports to the US. This comes at a cost to Chinese consumers and importers. Furthermore, it is a subsidy to American consumers. As long as the Chinese government is willing to subsidize exports to the US through pegging their currency at a low value, there will be and should be an exaggerated American trade deficit with China.
But when we talk of the traumatic effects of a reversal of this foreign monetary policy, I think we are prone to over-dramatize. The impact will be similar to having any subsidy removed. The market will adjust, the dollar will be devalued. Consumers will buy fewer Chinese imports, and life will go on, albeit at a lower unsubsidized standard of living. However, the American consumer looses nothing while the Chinese government provides this free lunch. It is the Chinese who pay the price for that duration.
Published: April 13, 2006 12:43 AM
"The correct model for international trade is the household." - Roger M.
The wage earner exports mental/physical labor and imports consumer goods and services. If what he earns exceeds what he spends, then he has a positive balance of payments. When he has a chance to purchase the same quantity of goods & services at WalMart, his cost for imports decreases and, therefore, his balance of payments grows more positive. If, on the other hand, he spends more than he receives, he then has a negative balance of payments.
Please note that a negative or positive balance of payment does not indicate whether or not he is more or less wealthy so long as his mental/physical condition & the demand for same remains constant.
Published: April 13, 2006 1:27 AM
"Let's be clear here: Roger M and Reactionary espouse state plunder and are only too happy to see it continue."
You must be reading another web site. I never said I espouse state plunder. I'm very much opposed to government spending and inflation. But both have little influence on the trade deficit, which is the subject.
Paul, finally something we can agree on!
George, your model is logical, but it doesn't fit the reality. The US does not depend upon exports for its wealth; we depend on our own productivity increses within the US regardless of whether we trade with anyone or not. If we exported nothing at all, and imported all consumer goods, we could still be the wealthiest nation on earth if foreigners could produce those goods cheaper than we could.
I haven't checked the figures lately, but but about a century international trade accounted for a mere 10% of our economy. How could we grow and become so wealthy on just 10% of the economy? Today, I think it's up to 25%.
Published: April 13, 2006 8:44 AM
David,
You miss my point. I would like nothing better than to see the federal government collapse completely. Unfortunately, there is no reason to believe it will for a long time to come. Legal immigrants continue to swell the payroll tax base and once all the illegals are regularized, tax receipts will soar. Lower labor costs will greatly mitigate the effects of inflation. The trade deficit, as Roger points out, appears to be nothing more than an accounting anomaly. There will be no currency crisis.
You have been given the opportunity to disprove Roger's thesis and have chosen not to do so.
Published: April 13, 2006 8:51 AM
Hernado Desoto in "The Mystry of Capital" makes a compelling case for the development of nations due to the formal legalization of private property. He shows how historical our society evolved to where it is today.
What is being missed on the issue of global trade is that our society evolved slowly. Consider what America would be like if America went instantanously from hand saws, axes and hand shovels to an economy of chains saws and back hoes. Would it be surprising if wealth were to concentrate in the hands of only a few with access to capital?
In fact, that is what has happened and is happening in much of the global economy. It also is the case where much of the wealth in third world countries is confined to small ethnic minorities. In light of this fact, it makes sense for those minorities to diversify there assets "not" based on return but on "safety". In effect, wealthy ethnic minorities should be willing to "pay" a premium to "lend" money!
The return for paying money to lend money will become apparent when angry mobs come for their throat!
Published: April 13, 2006 9:03 AM
Reactionary -
I pointed out one flaw in Roger's model above. To put it in his words:
"At some time in the future we will exchange that paper with even more worthless paper." So Roger acknowledges that we are ripping off of our foreign creditors. Fine - in a macro sense (i.e., ignoring the fact that foreign governments are involved), noone is forcing them to lend us money, and that's their problem. I agree with Roger this far.
"Where in the world will they find a better deal than the US?" Well, given the point above, is it impossible to imagine that there is a better deal out there somewhere? They know or at some point will figure out that we are ripping them off. Maybe not as bad as other fiat currencies (although even that is debatable currently), but currencies aren't the only way to store value - as Roger admitted at the beginning, fiat currency is actually an illusion. So, gold, oil, other commodities are all other stores of value. And as I noted, it's not just coink-dink that these commodities are sky-rocketing. And it's just the beginning, most likely, if the Chinese determine that they can get better returns on investing in their own infrastructure and natural resources.
It's impossible to predict what will happen, as all the players will adapt and react differently. And I agree with Roger that the big problem is government spending/debt, since we're all nominally on the hook for it. However, failing to realize the further effects of our government's inflationary and other policies is akin to the flawed economics so eloquently skewered by Hazlitt and others. One needs to dig deeper to realize that individuals in this country have responded to the distorted market signals created by our government and realize that when a correction comes, a lot of people are going to feel a lot of pain. And when that happens, our government tends to become more activist, not less.
Published: April 13, 2006 10:16 AM
Roger:"The correct model for international trade is the household. For example, my household has a huge trade deficit with Wal-Mart, the mortgage company, the utility company and others. None of those entities ever purchases a thing from me, but about 90% of my income goes to them. Why am I not bankrupt? Because I earn my money as an analyst for a healthcare company, not in trading with Wal-Mart. I buy food and clothes from Wal-Mart because I can buy them cheaper than I can make them myself. If I tried to make everything I buy from Wal-Mart, and achieve self-sufficiency, I would have to quit my day job and would become very poor."
So? Mueller did not discuss bilateral trade deficits with anyone, but the overall trade deficit with everyone. And if you as a household spend a lot more than you earn and thus have a individual trade deficit you will get poor (unless
you spend some of your money on goods that will generate future income, i.e. invest them).
"Two groups borrow foreign money—businesses and the federal government."
Not really true. Households borrow money from abroad indirectly through the massive mortgage debt they pile up. The people who finance these mortgages are , apart from the Fed, foreign bond buyers.
"If all foreigners refuse to loan to all US businesses, US interest rates would rise. Big deal! Then Americans would start to save more."
Yes, and the housing bubble would burst and the U.S. would fall into a recession.
Paul Edwards->"So, here is my view: the solution to the trade deficit “problem� to the extent that it is a problem, is elimination of government inflation and spending."
On this, I agree.
"Further, I’d like to suggest that the trade deficit we have with the Chinese, for example, is a result of the Chinese government’s policies more than our own government’s. I say this because the natural result of domestic inflation, all other things remaining equal, is a quick depreciation of the dollar on the foreign exchange markets. This results in higher costs for imports to the US, resulting in a very quick curtailment to imports back to their natural level. Therefore, I don’t think excessive domestic inflation can cause sustained trade deficits."
As I believe I've stated before, the effect of inflation on the trade deficit depends just on which prices are bid up by it. If the main effect is bidding up asset prices, as have been the case in the U.S. during the last decade, then this will have a strong increasing effect on the trade deficit. We have empirically seen not only in the U.S. but in other countries with high asset price inflation as well, like Australia (until a year ago), the U.K., Spain, France and Sweden that monetarily driven asset price bubbles have been associated with such a strong increase in domestic demand that this have overwhelmed the partially counteracting effect from a weaker currency.
The form of inflating undertaken by the Chinese government as well as a few other Asian and oil-exporting countries, when money is used to bid up the prices of foreign assets rather domestic ones, this will of course have the opposite effect on the trade balance. But I think the effects of this is likely less important than the effects of Fed policy.
Published: April 13, 2006 10:29 AM
When the paper money collapses the companies and peeople who own real property and guns will still own real property and guns. They will organize into city-states.
Published: April 13, 2006 10:43 AM
"How could we grow and become so wealthy on just 10% of the economy?"
Because (as I tried to explain, above) the balance of payments are no indication of wealth, therefore, wealth is generated primarily by 1) the entity's capacity to produce and 2) the demand for its production.
Published: April 13, 2006 10:50 AM
Again, how does one explain the willingness of foreigners to continue to invest in the United States in light of the rate of return?
A rate of return that would eventually have to contend with an equalization of purchasing power parity presumably at some time in the future.
Don't foreigners know that their investments will have a long term negative return?
Where did Richardo's theory of comparative advantage go wrong?
Richardo's theory does not account for the speed at which modern technology can transfer capital to the advantage of a small minority of people in a developing market. There simply is no middle class and probably no prospect for ever having a middle class. The modern world will simply give too small a minority too much of an advantage in an underdeveloped economy.
It is these small fantastically wealthy "ethnic" minorities who are hedging their investments against the hordes of what they know must be disgruntled poor "endogenious" majority population that is leading to what seems like investments with poor relative rates of return. Especially, poor relative rates of return considering the huge profits they are garnishing from their domestic investments.
Published: April 13, 2006 11:34 AM
Mark, I'm not real clear on what your point is, but this may help: Technology isn't really to blame for the concentration of wealth in poor countries. The culprits are lack of private property (as De Soto writes) and the lack of protection of property. (Have you seen World on Fire : How Exporting Free Market Democracy Breeds Ethnic Hatred and Global Instability by Amy Chua?)
Chua's book is very interesting, but she gets the cause wrong. In most poor countries, no one enforces the laws that protect property, so a handful of influential politicians and cronies use family ties, political ties and bribes to make money and protect it. That is how the ethnic Chinese in Thailand, Indonesia and the Pilippines have protected their businesses for centuries. No middle class can develop because the poor have no money to bribe officials and no access to political power. The solution would be independent, uncorrupt, judges and policemen.
Why do foreigners loan us their money at such cheap rates? Because their options are so limited. What other nation offers opportunities for a decent ROI where the government won't steel the money through corruption, high taxes or high inflation? Compared to other countries, our taxes and inflation is low. Even Europeans are investing heavily in the US because they're losing freedoms every day and their economy is dead.
Published: April 13, 2006 12:17 PM
PS, Borrowing for 10 years at 4.5% is so low as to be almost immoral! That's just 1.5% above inflation, if you believe gov stats.
Published: April 13, 2006 12:20 PM
Roger, yes I have read Chua's "World on Fire". While I totally disagree with her assessment of how we came to have a large middle class and her proscriptions for the developing world, her many examples can not be ignored.
Roger I will be blunt about this. I believe that to ignor that any economic system or political system is but substrate of a larger biological system predicated on Darwinian evolution is proscription for disaster.
The United States has had the advantage of evolving technology and capital slowly. Irrigation systems were dug by hand, trees were chopped by axes, goods were transported by foot or horse back and the marketing system consisted of small vendors in a village. Not to mention democracy was a very limited notion for much of U.S. history.
My contention is that even in an ideal non corrupt system, advantages of instant availablity of modern technology and capital would inherently lead to tremendous wealth polarization.
Just think if you were plowing your fields with an ox in colonial american and someone showed up with John Deere tractors, back hoes and lorries to ship produce to a distant market developed with the aid of modern media. You do see the prospect where only a few would gain much advantage from such a system?
But why should we ever assume an ideal?
I will offer the opinion that our ideals are myths that are allowed to evolve because of the reality we enjoy. To assume that they are the reason for the reality is putting the cart before the horse.
People do fear their governments and the wrath of their own people. Which will continue the trend of purchasing of US dollars and the continued discrepency with much of the world of purchasing power parity. Which in turn will continue the trend of the huge trade imbalances. In effect, the global economy is one big positive feedback loop.
Published: April 13, 2006 1:41 PM
Stefan,
If the deficit is a problem, what is its solution? This article’s conclusion has no call for some sort of action to fix this deficit problem. The reason for this, in my opinion, is that there is no free market solution to the “problem� of a trade deficit.
Furthermore, if all regulatory, monetary and fiscal activities of Washington which hamper our domestic markets, were to be radically reduced tomorrow, but governments such as the Chinese continued to subsidize their own export industry, we would continue to see a higher than natural trade deficit with china.
In this scenario, would we continue to define the trade deficit as an American problem? I would define it as perhaps a Chinese problem and a bonus to Americans. What’s the saying, “don’t look a gift horse in the mouth�.
Published: April 13, 2006 1:44 PM
Mark,
If what you say is true, how could any nation develop? The progress of Japan, Korea, Taiwan, Hong Kong and others contradict you ideas, I think. When an American shows up in Columbi with high technology and capital, the wealth gap already exists; the Columbians are already poor and the American already rich. The encounter doesn't change that. But if the Columbia government would protect property rights, the rich American would have to pay for the land or minerals he extracts with the use of his technology Columbian land owners and labourers would become wealthier. But in reality, a small elite have already used corruption to gain control of the most valuable land, minerals and other assets of the country, so the little people don't benefit.
Read anything by Peter Bauer. He explains it better. Trade can benefit poor countries a lot, but they have to have the right institutions in place for the effects to spread to a lot of people.
Published: April 13, 2006 1:55 PM
Stephan,
Are you suggesting that without inflation and deficit spending we would not have a trade deficit?
Published: April 13, 2006 1:58 PM
Roger, notice that with the exception of Taiwan the nations you mentioned have a strong anglo connection as far a governance. Throw in Chile and Singapore and no successful nation today at its inception was a one man one vote democracy.
Further, Columbia and other third world countries do have property rights, I think. However, it is DeSoto's contention that the acquisition of those property rights are cumbersome. In other words, accessible to those who can hire attorneys. Not to mention much of the poor are legally squating.
Again why should I contend that the game players in the global economy should be benevolent?
After all where is the benevolence of our government when it comes to the agri-business?
More likely we are going to see more blood shed and the key participants, the elite, in the game know it. This in turn in my opinion is the hidden over-valuation of the US dollar and this positive feedback loop will likely continue with no end in sight.
Published: April 13, 2006 3:33 PM
"If the deficit is a problem, what is its solution? This article’s conclusion has no call for some sort of action to fix this deficit problem. The reason for this, in my opinion, is that there is no free market solution to the “problem� of a trade deficit."
I am not Antony Mueller and so I cannot speak for him, but my free market solution (which I am nearly certain he would agree with me about) would be for the Fed to stop inflating, for the budget deficit to be eliminated and for the taxation of savings to be abolished. That would dramatically reduce the trade deficit, and it would make the remaining trade deficit a case of a good trade deficit (To the extent trade deficits finances sound investments it is not only not a bad thing, it is a good thing).
Roger-"Stephan,
Are you suggesting that without inflation and deficit spending we would not have a trade deficit?"
No, not necessarily. But it would most likely be much lower and what remains of it would be a case of good trade deficits.
Furthermore, if all regulatory, monetary and fiscal activities of Washington which hamper our domestic markets, were to be radically reduced tomorrow, but governments such as the Chinese continued to subsidize their own export industry, we would continue to see a higher than natural trade deficit with china.
In this scenario, would we continue to define the trade deficit as an American problem? I would define it as perhaps a Chinese problem and a bonus to Americans. What’s the saying, “don’t look a gift horse in the mouth�.
Published: April 13, 2006 5:08 PM
“…my free market solution (which I am nearly certain he would agree with me about) would be for the Fed to stop inflating, for the budget deficit to be eliminated and for the taxation of savings to be abolished.�
I think your solution is spot on and I suspect Antony probably feels the same.
As long as at the end of a sophisticated analysis of our trade deficit woes, the conclusion is always simply that we need to reduce or eliminate government inflation and spending, then I guess I shouldn’t complain. But I truly must confess that I cannot see clearly how either of these can really be known a priori, or by empirical evidence, to encourage a trade deficit, for the reason that I mention: that domestic inflation and the ensuing rising domestic commodity prices would result in a quick reduction in exchange rates in the international markets, equalizing purchasing powers, with the necessary tendency to reduce and level off imports, and to encourage and level off exports. But I have seen your argument; you’ve seen mine so I guess we should just agree to disagree.
Published: April 14, 2006 12:33 AM
I wonder if both China and the USA are in some kind of agreement. Americans need cheap goods to keep the circus operating in the USA so as to keep people happy by consuming. China on the other hand needs to keep its people employed and fed to stop them from rebelling. China uses the truck loads of US dollars to by REAL resources from idiot countries who are happy to give them away for printed paper. When nations and people start to demand real value for their goods and services then the charade will be exposed.
Published: April 14, 2006 6:10 AM
Hi Paul,
You stated that:
"domestic inflation and the ensuing rising domestic commodity prices would result in a quick reduction in exchange rates in the international markets, equalizing purchasing powers, with the necessary tendency to reduce and level off imports, and to encourage and level off exports".
Wouldn't your answer depend on the behaviour of the central bank?
Perhaps a rising price level may see the Central bank increasing the interest rate to combat the inflation.
If this were so then the rising interest rate could make US interest rates comparatively higher than other nations.
This could led to capital inflows from foreigners wishing to take advantage of the interest rate differential.
So the foreigners would sell their currency and buy the US dollars for which they need to invest in the US banking system.
Thus, an increase in the demand for $US would see the exchange rate rising not falling.
This would possibly increase imports and reduce exports because exports have become relatively more expensive.
My analyis is crude of course because if US exports use imported materials then the rising exchange rate could actually reduce the production costs for US exporters.
The truth is I really don't know what the outcome would be. Though I'd probably rather leave it too the market than government / central bankers to muddle up.
Cheers
Published: April 14, 2006 9:24 AM
Alan,
You addressed your comments to Paul, but if I may but in until he responds, I think you're exactly right. The interactions between fx rates, fed policy, and trade are just to complex to specify exactly what will happen in a given scenario. But you might argue that, even though our fed money policy is too loose, it's tighter than that of other countries. That makes our interest rates higher relative to others and attracts foreign investment, which raises the value of the dollar against other currencies. The higher dollar value makes imports cheaper and therefore increases imports.
Keep in mind, too, that a big chunk of foreign investment is direct, that is, purchasing or starting companies in the US. The US receives the second highest foreign direct investment in the world behind China. Foreigners want to invest here because of our freedom and our dynamic economy. But that investment also raises the value of the dollar and increases imports.
Published: April 14, 2006 12:36 PM
Hi Alan
I stated that
"domestic inflation and the ensuing rising domestic commodity prices would result in a quick reduction in exchange rates in the international markets, equalizing purchasing powers, with the necessary tendency to reduce and level off imports, and to encourage and level off exports".
To which you replied:
“Wouldn't your answer depend on the behaviour of the central bank? Perhaps a rising price level may see the Central bank increasing the interest rate to combat the inflation.�
My meaning of “domestic inflation� implies a particular behavior of the domestic central bank (the fed): loose money, monetary inflation and low short term interest rates. With this almost necessarily will follow increases in terms of the domestic currency in prices of high order internationally traded market commodities. The international markets (bourse, etc) pay attention to this and are speculating in this by the minute. These things are detected there way before the domestic consumer catches wind of it. I mean way before.
“If this were so then the rising interest rate could make US interest rates comparatively higher than other nations.�
Yes, but the original point made was that the fed’s inflation is causing an unhealthy trade deficit. I don’t think the argument was that consistently tight fed monetary policies causes harm. So my arguments all assume loose fed policy.
“This could led to capital inflows from foreigners wishing to take advantage of the interest rate differential. So the foreigners would sell their currency and buy the US dollars for which they need to invest in the US banking system. Thus, an increase in the demand for $US would see the exchange rate rising not falling.�
Yes, but with the opposite behavior, a loose fed policy, high inflation, and massive market distortions how then do we square with our trade deficit with china?
“This would possibly increase imports and reduce exports because exports have become relatively more expensive.�
I agree, but see answers above.
“My analyis is crude of course because if US exports use imported materials then the rising exchange rate could actually reduce the production costs for US exporters.�
I think your analysis is pretty good, but it assumes the opposite of what my argument assumes. And I do believe the question is how does loose fed behavior, rather than tight, lead to a “bad� trade deficit.
“The truth is I really don't know what the outcome would be. Though I'd probably rather leave it too the market than government / central bankers to muddle up.�
I’m with you all the way on leaving it to the free and unhampered market! :)
Published: April 14, 2006 1:04 PM
We could make a good case that monetary policy has no effect on imports for these reasons: A loose policy spurs consumption of imports, but it also lowers the value of the dollar in the fx market and makes imports more expensive, thereby correcting the the surge in consumption. A tight policy reduces consumption, but raises the value of the dollar and makes imports cheaper, thereby encouraging imports.
Published: April 14, 2006 1:22 PM
Roger M:
If China, et al., have to buy US government debt so that the US government can turn around and lend it to the US concumer, without which he can't consume, then the dollar must inevitably lose value, the question being how long China, et al., will continue to receive these increasingly worthless dollars in return.
You're welcome to believe that this can go on indefinitely and that the US can therefore borrow and spend its way to prosperity. But since households can't do so, how can you believve that the economy as a whole be able to do so?
Published: April 14, 2006 2:10 PM
David,
China doesn't have to buy US debt? Who's forcing them? I think they want to buy it in order to keep pressure off them to devalue the yuan. But that's their choice.
The US gov doesn't lend money to consumers; it has to borrow huge amounts to pay its own bills. The US consumer has borrowed an enormous amount, but from US banks and credit card companies. That borrowing can't continue forever. But when US consumers quit buying imports because their debt is too high, that will cause the value of the dollar to rise, not fall, because foreigners will have fewer dollars to unload.
If China get's tired of taking our money, they can always raise the peg to which they've tied the yuan to the dollar. Then Chinese products would become more expensive in the US and we would buy fewer.
If you want to see the effect of printing money on trade, look at oil. Arabs price oil in dollars. Over the years, they have tired of the dollar losing value because it makes their oil worth less in Europe and Asia. So they have tried to keep up by raising oil prices. Higher oil prices then reduce consumption of oil in the US.
Published: April 14, 2006 2:51 PM
Roger,
China has to buy US govt debt because if it didn't, the US economy would collapse and, with it, China's all-important export market. So to keep the charade going, China must buy US govt debt (rather than hard assets like oil companies), never mind the terrible returns. The Fed can then keep interest rates artificially low so that banks can cheaply lend consumers the money they need to buy the trinkets that allow China to turn around and buy US govt debt.
The problem, however, is that as the dollar depreciates amid the Fed's money-pumping, China's massive dollar reserves are becoming increasingly worthless, meaning that sooner or later (and it's already late), China (and others) will have no choice but to look elsewhere to invest their dollars. And it won't take a large-scale sell-off of to effect the dollar's collapse.
In the end, it's all about the den of thieves that is the global banking cartel waiting to see who blinks first, none of them wanting to be left holding the bag (of worthless paper) once the stampede in on in earnest.
As for oil, the Arabs only price it in dollars because they presently have no choice. (Look what happened to Saddam when he tried to price Iraq's oil in euros.) But as the dollar's status as the world's reserve currency inevitably erodes, its choke-hold on oil will also erode, and when it does, the US economy will be exposed as the house of cards that it is.
Published: April 15, 2006 8:41 AM
Gentlemen, am I mistaken that the practice of countries with a surplus that increase their money supply by the amount of their surplus as well as re-investing their surplus with the deficit country are in fact double-dipping ? Or should I say printing money ? Is this practice causing a problem ?
Published: April 16, 2006 3:14 AM
Peter, the arguement that has been posited is that many asian governments have increased their dollar holdings as a hedge against a repeated run on their currencies.
The result has been to overvalue the US dollar in terms of purchasing power.
My contention is that more needs to be said. Namely, that foreign governments are creating long term horriable returns for private citizens of their country that invest in the U.S.
So why are the extreme wealthy investing in the US when they know the future value of their investment will be negative when a revaluation of their domestic currency must a some point ensue?
Published: April 16, 2006 10:54 AM
Overall a fine article from Prof Mueller - with just one (main) quibble.
He argues that, come the much-anticipated re-balancing, it will be much easier for China to switch on consumption and quit saving than for the US to rebuild higher order goods industries by doing the converse.
Differences fo national predilection and simliarities of human weakness aside, however, this is exactly the opposite view to that expressed by the likes of Machlup in "Stockmarket Credit & Capital Formation" where, as he points out, removing much less specific resource from consumption and redeploying them higher up the chain entails far less friction and less severing of often unseen interlinkages than does the partial liquidation of a top-heavy productive structure.
If we imagine US factories had succumbed to some sudden epidemic of a malignant corrosion, it would surely be easier to re-organize workers and resources to rebuild these - in place of yet more homes, law offices, and shopping malls - than it would be for the Chinese to shut down exactly the right number of highly-interconnected and mutually-dependent mines, mills, and machine shops, so as to push everyone employed there into a job selling designer jeans while brandishing a Mastercard?
Published: April 18, 2006 6:03 AM