Isn't the Capital Surplus a Good Thing?
The man on the street passionately believes that we ought to sell more stuff to foreigners than we buy from them. But he also believes quite strongly that it's good if foreign companies build factories here, rather than Americans exporting capital abroad. So when we free market economists point out that the two positions are mutually exclusive, that at least causes the protectionist to scratch his head. Remember: a positive trade deficit must yield a positive capital account surplus, i.e., a net inflow of foreign investment in US assets. FULL ARTICLE
Comments (157)
But, at some point the the capital flows must reverse, or else the capital surpless will tend to infinity. The point being that capital flows are based on prices of capital, and the myriad of goods and services in different countries. Prices themselves are derived from the balance between supply and demand. So in essence, capital flows and trading surpluses signify a balance that is continuously being adjusted through the independent decisions of millioins (billions?) of individuals.
I don't think capital surplus, when viewing the global economy through from an individual perspective, has much meaning. Capital surplusses only make sense now because of the currency and legal zones that divide this planet. While the latter might be okay the former is not. Central banks, through printing money, distort prices (the affects of which have already been discussed). This price distortion is different across different currency zones (different CB => different printing speeds). This mucks up the calculations people make on a daily basis which in turn distorts capital flows.
In the case of China, all that is happening is that the Chinese central bank is printing yuan to match the Federal Reserve's printing of dollars. The exchange ratio between the two remains the same. Unfortunately, for most Chinese that means conumption is being sacrificed for capital spending (building skyscrapers, factories, intermediate goods to make final products). In the US, it is the opposite in that capital spending is being sacrificed for personal spending (increased personal debt, higher end goods in exchange for not manufacturing anything).
Phew, that was a long post. The China/US part needs a bit of work.
Published: January 22, 2007 8:40 AM
I wonder how much the trade deficit has to do with the gigantic hedge fund industry. Their practice is to essentially borrow from all the central banks at below equilibrium interest rates, reinvest in higher yielding assets anywhere and pocket the difference as profit.
That difference may be the trade deficit.
In that case a change in central banking policies could crash the industry and cause a recession as Schiff predicts.
Published: January 22, 2007 8:54 AM
Wow, what a shock to find a shill for the "deficits don't matter" crowd here at the Mises Institute!
What mainstream economists (and obviously Mr. Murphy) don't understand (and what Austrian economists like Schiff DO understand) is that if it weren't the world's "reserve currency," foreign central banks would have long ago abandoned the "dollar" (i.e., the unconstitutional, irredeemable Federal Reserve Note), ending the massive Ponzi scheme that constitutes the world's credit-based monetary system. (Not for nothing, after all, did Henry Ford long ago say that if the American people understood our banking and monetary system, "there would be a revolution by tomorrow morning.")
Let's be clear: We've gotten away with exporting our inflation for a couple of decades now, and when foreign banks have finally had enough of buying an increasingly worthless piece of paper, they will stop doing so (precisely as China intends -- http://quote.bloomberg.com/apps/news?pid=20601087&sid=a3qbrjQctNl0). And when the stampede is on in earnest, a "Nash equilibrium" will have been created whereby "an ideal financial strategy for everyone on Earth [will be] to buy as much gold and silver as they can, as soon as possible" -- http://www.safehaven.com/article-5205.htm
That said, I can only reiterate my shock that a piece so in conflict with Austrian economics could be published on this site.
Published: January 22, 2007 9:03 AM
'what we apologists are defending is the spontaneous outcome on a free market.'
OK, so charitably we can thank Mr Murphy for what must surely be the introduction to the principle of how one should think about trade deficits in a free market.
I am looking forward to the next part, where one introduces fiat money, central bank intervention in global interest rate markets, state mercantilist policies etc.
Yours patiently etc.
Published: January 22, 2007 9:14 AM
A capital surplus is not good for China just like a trade deficit is not good for the United States, at least not one of this magnitude. I think that was the thrust of the article.
Published: January 22, 2007 9:19 AM
Let me preface my comment by saying I'm not an economist, but only a person of ordinary intelligence. The author begins by saying
"If Americans spend more on current goods and services sold by foreigners, than foreigners spend on current goods and services sold by Americans, this necessarily means that foreigners must be investing more capital in American assets than vice versa. This isn't an economic theory, but rather an accounting tautology."
But this isn't so. If purchased goods are accumulating on our side of the fence while US dollars are piling up on the other there is no rule stating these dollars must be spent on goods and services within the US. Dollars are traded freely throughout the world. They just enter the global economy.
I recall a couple of generations back there was some serious concern over Eurodollars. These are them-- dollars held in foreign banks and by individuals. The system is stable in spite of the tremendous overhang of unrepatriated dollars in circulation because they are held to be a desirable store of value. And thus the holders of those dollars conspire to keep the dollar stronger than it might otherwise be. So Americans enjoy an advantage other nations with a trade deficit might not enjoy, as their own currencies are not a popular store of value.
The moral is, the system works unless it is shaken. A small crisis-- let's say in the solvency of Medicare-- could precipitate a rush for the exits as the dollar was abandoned. In the aftermath we would find what remains of the United States amid the wreckage.
I would appreciate any comments showing the error of this view.
Published: January 22, 2007 9:24 AM
Michael, in the case of U.S.dollars held by foreigners, the dollars are the American "asset" invested in by foreigners.
I enjoyed Murphy's article except for the last analogy, which I found confusing. Consider the question the wife asks of the husband, "How much did you earn by selling your labor or merchandise last week?" I, as the husband, might have answered $5,000.
If capital surpluses are employed to finance investment goods that earn a rate of return in excess of the return paid to foreigners, U.S. equity, or U.S. future income-generating wealth increases. To the extent that capital surpluses are used to finance present consumption-type goods (and services), U.S. equity falls. Essentially future consumption has been traded off for enhanced present consumption. Even though the decisions for such a tradeoff were voluntarily made by the present population, the future population did not volunteer to pay for the present generation's consumption.
Published: January 22, 2007 9:48 AM
We've gotten away with exporting our inflation for a couple of decades now, and when foreign banks have finally had enough of buying an increasingly worthless piece of paper, they will stop doing so
What will make them stop buying slowly increasingly worthless paper and switch to rapidly increasingly worthless paper?
The EU, Japan, and China all have greater debt and greater future liabilities due to demographic shifts. What nation has a relatively sounder currency than the U.S. dollar, with less debt, lower inflation, and is large enough to supply global trade?
Published: January 22, 2007 9:56 AM
Matt, all fiat currencies are in a race to the bottom to prop up exports, and while "currency markets" presently trade in the fluctuations between them, all of these currencies will one day return to their intrinsic value: zero.
Thus do hard assets (including and especially gold) represent the only viable alternative, and thus will the stampede soon be on to own them.
The bottom line is that you can't have free trade in general without free trade in particular, i.e., in money. What you get instead is what we have now -- a fiat-based free-for-all that has created global imbalances the likes of which the world has never seen. And when it finally starts to unwind, there will be no stopping it.
Published: January 22, 2007 10:20 AM
I don't know if this question has been asked and answered yet but.....
If we have a trade deficit and then the country or countries we have a deficit with will have to either invest in our country or buy our products or something of that nature. This is because the money belongs to our government. If we were on a pure Gold standard this would not be the case. How is this free market? If we had commodity money this would not be the case (not just a gold standard).
If one country produced a lot and freely obtained our gold then they would have a bunch of gold and we would have a lot of capital. They would not be obliged to return the favor. I am not arguing against commodity money here, and I am sure a free market situation might revise our trade deficit, however, can we really say a trade deficit does not matter?
Published: January 22, 2007 10:46 AM
Nicely done! I especially liked the part where Schiff claims that foreign investors are stupid for investing in the US.
Sometimes I ask opponents to imagine that instead of cars and oil, the US imported nothing but gold. How would that affect their feelings about the trade deficit. Obviously, they would favor it because they value gold. So they're upset about the trade deficit because they don't value cars and oil.
Published: January 22, 2007 11:34 AM
RogerM, investing in the US is one thing; buying US government debt (bonds) at yields that are below the real inflation rate -- http://www.shadowstats.com/cgi-bin/sgs? is quite another. It's stupid, in fact, but given the absurdity of the system -- i.e., of a worldwide credit-based Ponzi -- even more stupid would be to NOT buy our government debt, since this is the only thing keeping the Ponzi afloat. At least for now.
As for Peter Schiff, unlike Robert Murphy, he is a dedicated Austrian who understands why trade deficits that arise in this manner represent gross imbalances that cannot be sustained. Nor is Schiff just selling books, as his investment firm's success depends entirely on how well he invests his clients' money.
And let's be clear here, the sites where Schiff publishes his pieces -- Financial Sense Online and SafeHaven.com -- are very much in the sound money (i.e., Austrian) camp. And for him to be attacked here at the Mises Institute if frankly an outrage.
Published: January 22, 2007 12:10 PM
David: "...buying US government debt (bonds) at yields that are below the real inflation rate...is quite another. It's stupid, in fact.."
It may seem stupid to you, but a lot of foreigners think it's a great value. Should we refuse to sell bonds to foreigners because we think they're stupid? Isn't the whole idea behind subjective value the idea that what you value I may think is stupid?
Neither are Americans stupid or greedy or materialistic or any of the other insults socialists hurl at us just because we see greater value in imports than some domestic items.
Ignore the stylized accounting scheme called the national accounts. It was designed by a socialist to promote socialism, in this case governmental control of trade. It merely records the movement of cash and has little connection with national wealth. No where in those accounts will you find an entry that indicates the wealth created through trucking burning imported oil, or the productivity increases brought about by capital investments in new equipment by Toyota.
A short justification for free trade is that if people are free to purchase what they value, without coercion, everyone will be better off, even if someone else thinks they're stupid.
Published: January 22, 2007 1:03 PM
Ultimately, there are only things that the Chinese or anyone else can do with American money. Buy American goods, spend it as tourists for American services, or buy American land or businesses.
If they buy land or businesses all it does is permit them to generate American money and restart the cycle.
Published: January 22, 2007 1:11 PM
"No where in those accounts will you find an entry that indicates the wealth created through trucking burning imported oil, or the productivity increases brought about by capital investments in new equipment by Toyota."
That's statistically impossible to capture. So instead, let's reduce the transaction to its basics: China is agreeing to accept shares of stock and IOUs in exchange for real goods and services. You could propose this to your grocer, and let me know what he says.
Bottom line, and this is fundamental Mises, imports must ultimately be paid for with exports. Has fiat money gotten us out from under this iron law? I don't see how it can but I agree there are lots of people out there losing money betting against the USD.
Published: January 22, 2007 1:20 PM
RogerM, you obviously don't understand what I'm saying, which is that foreign CENTRAL BANKS have no choice but to buy our debt, else the system collapses. The banks are all getting itchy trigger fingers, however, and since they are essentially a den of thieves, with no honor among them (just like the states they represent), you can be sure that they are all watching each other to see who goes for his gun (i.e., dumps the "dollar") first.
As for Americans buying foreign goods, three points:
1) Americans are buying those imports because they're cheap, and they're cheap because the labor's cheap, which allows us to essentially export our inflation.
2) That inflation is further kept at bay by the central banks' massive purchases of US government bonds, which keeps their yields down and thus interest rates.
3) The imports are being purchased largely via credit card and/or home equity extraction, as Americans have a negative savings rate for the first time since the Great Depression.
Robert Murphy is welcome to think this insane state of affairs is sustainable -- i.e., he's welcome to join Kudlow, Laffer, and other carnival barkers in believing that our "Goldilocks" economy will stay "just right" forever -- but Peter Schiff knows otherwise.
Lastly, as we are all coerced into using the US government's "legal tender," the "free trade" you refer to is a farce.
Published: January 22, 2007 1:27 PM
David: "...buying US government debt (bonds) at yields that are below the real inflation rate...is quite another. It's stupid, in fact.."
Quite smart in fact , if buying U.S. government bonds entangles the U.S. military into the stability of nations which will only except dollars for payment of oil.
Why buy a military when you can rent one?
Published: January 22, 2007 1:42 PM
"...buying US government debt (bonds) at yields that are below the real inflation rate...is quite another. It's stupid, in fact.."
If a foreigner has limited options to invest (lets say their own country and the US). What if the inflation rate is 25% in their country? And, in your scenario, lets say they are losing 2% real returns in the US...aren't they really making 23%.
This might be one of several complementary explanations for an inverted yield curve; people will accept a lesser return for lesser risk (subjectively determined). Empiracally, the nominal return for the US treasury bond has been quite safe.
Published: January 22, 2007 2:02 PM
Mark, I'm not sure what you mean or even if you're serious, but a relatively small divestiture of US bonds by OPEC was enough to send bond yields higher, so just imagine what a major sell-off will do:
http://www.bloomberg.com/apps/news?pid=20601009&sid=aqnC4ssoiBFc&refer=bond
Published: January 22, 2007 2:11 PM
Wonderful essay, Dr. Murphy.
Roger M. touches on what I think most people miss in this entire debate- Americans are castigated for profligate consumption when discussing the trade deficit, but really, don't items like a Toyota truck, a Nokia cellphone, or a Dell computer have certain capital qualities? In other words, don't such items make Americans more productive than they otherwise would have been?
As for the issues of fiat currency, I don't think it really matters as far as the trade deficit is concerned. Every other foreign government is increasing money supply just as rapidly, or more rapidly, than the United States. So, unless you wish to blame the trade deficit on the Fed being one of the least irresponsible central banks (actually, it is one of the arguments I would make), then you can't blame the Fed for the trade deficit.
Published: January 22, 2007 2:16 PM
Pepe, I'm not talking about individuals but the massive purchases of foreign central banks, which could invest their dollar reserves in any number of profitable ways (including gold) if keeping the Ponzi going weren't more important.
As for individual foreigners, why settle for a loss of 2% when you can buy gold and silver on the cheap and reap the rewards accordingly?
Published: January 22, 2007 2:17 PM
Robert,
Since you are making a couple of predictions for 2007, care to speculate on the price of silver and gold ending 2007?
Thanks
Published: January 22, 2007 2:19 PM
Reactionary: "Bottom line, and this is fundamental Mises, imports must ultimately be paid for with exports."
I assume you mean exports of goods and services, because we are exporting something: stocks and bonds.
I don't think the idea that imports must be paid for with exports is Mises. I'd be interested in a reference to Mises if you have one.
International trade is nothing more than the expansion of the division of labor, which Mises championed. Chinese can make some things, especially consumer goods, more cheaply than we can because they have an advantage in labor intensive goods. We have an advantage in capital intensive goods and we have an advantage in securities such as bonds and stocks. There's no reason we can't continue to pay for imports with stocks and bonds, and we'll continue to grow wealthier as long as our economy grows faster than our issue of such stocks and bonds.
David: "CENTRAL BANKS have no choice but to buy our debt, else the system collapses."
I don't agree that central banks have no choice. In fact, China has chosen to buy our debt in order to keep its yuan at a low value relative to the dollar. The Chinese are mercantilists and so this makes sense to them, even though in reality they're subsidizing our purchases of their products.
Published: January 22, 2007 2:23 PM
Yancy Ward,
"Every other foreign government is increasing money supply just as rapidly, or more rapidly, than the United States."
It's a race to the bottom, in other words, and when enough people decide that holding ANY of these increasingly worthless pieces of paper is worth it, the world will return to sound money.
Published: January 22, 2007 2:26 PM
RogerM,
"I don't agree that central banks have no choice. In fact, China has chosen to buy our debt in order to keep its yuan at a low value relative to the dollar."
And it must do so in order to keep selling us their goods on the cheap. Hence, the PBoC has no choice but to buy our debt.
They very much want out of this ultimately losing proposition, however (who wants to hold onto an increasingly worthless asset?), and therefore is working feverishly to expand its other foreign markets and develop its internal markets.
Published: January 22, 2007 2:34 PM
David,
While I think the currency systems will eventually collapse and give birth to a new order (they always have in the past), it may not happen for a century or more. So, I think having some assets in precious metals to be sound strategy, but I would not put all my eggs in that particular basket. In the event of a financial collapse of the dollar, gold and silver may not be the best items to actually own. I would think basic survival items to be more prudent.
Published: January 22, 2007 2:37 PM
"Last year, the Asian monetary authorities, together with the central banks and state investment agencies in oil-exporting countries, bought about $770 billion in foreign-currency assets. These official purchases financed most of the estimated $870 billion U.S. current-account deficit in 2006, according to research by the Federal Reserve Bank of New York. If the petrodollar surpluses dwindle, the job of sustaining U.S. consumption will fall squarely on the Asian central banks. Should the monetary authorities in China, Japan, South Korea and India continue to feed the American spending habit or invest their surpluses elsewhere?"
Good question:
http://www.bloomberg.com/apps/news?pid=20601039&refer=columnist_mukherjee&sid=airEHuMlkGao
Published: January 22, 2007 2:40 PM
As the above article concludes:
"The monetary authorities in Asia can't diversify out of the dollar with the same degree of nonchalance as their counterparts in oil-exporting nations. Asia is married to a model of export- led growth whose continued success depends on a strong dollar. Asia keeps its currencies undervalued in order to sell goods to the U.S. on the implicit understanding that it will also provide the financing -- through the purchase of U.S. Treasury and agency bonds -- to sustain the consumption. If Pimco's Toloui is right and oil producers now hold a quarter of the world's sovereign assets, Asia and the U.S. may not be able to continue their private arrangement for long. Think of it as a game of musical chairs between the U.S. and Asia. The oil exporters now control the music."
Published: January 22, 2007 2:43 PM
As for individual foreigners, why settle for a loss of 2% when you can buy gold and silver on the cheap and reap the rewards accordingly?
-----------------------------------------------
I appreciate that we are generally speaking of large governemnts. I was using the micro method of analysing an individual utility maximizer and extrapolating his behavior in summation to be that of a macro economy (just one of many ways of simplifying for exposition purposes).
Lets take China. I think it can be said that by their actions the Chinese government is generally a risk-averse investor. Whether they are worried about their liabilities or it is the behavior of a governemnt beuraucrat not being motivated by profit I do not know...but they are buying US trasuries.
As for Gold or Silver: I like them as investments. BUT, it seems that you imply that these investments always go up? (however measured). But, lets say the Chinese governemnet has fiscal outlays that are relatively predictable over the next five years; Who knows where the price of gold will be in five years or one year. In their judgement, the US treasury is a more predictable payoff. This is nothing more than matching assets and liabilities.
p.s. I do not reject your concernes about fiat money, etc.
Published: January 22, 2007 2:45 PM
RogerM, investing in the US is one thing; buying US government debt (bonds) at yields that are below the real inflation rate -- http://www.shadowstats.com/cgi-bin/sgs? is quite another. It's stupid
The same people who think that foreigners are stupid for buying our debt are the same one who lament the trade deficit. What better way to improve our own lot by borrowing money at below market rates?
Published: January 22, 2007 2:55 PM
I can't address individual comments, but let me at least throw one post into the fray...
For people talking about central banks etc.: Schiff was condemning trade deficits per se. He said nothing (in this article) about fiat currency. If we had a pure 100% an-cap country, and it ran a trade deficit, Schiff's arguments would mean the country was irresponsible that year. Are you guys saying Mises and Rothbard would agree with that?
Next point: Suppose the Fed halted the money supply, i.e. stopped all new dollar creation, and moreover that the US gov't eliminated the personal income tax and cut spending by 50%. What do you think that would do to the strength of the US dollar and to net investment into the US? Are you people saying the US trade deficit would go _down_ under this wonderful scenario? I say it would go way way up.
You're right, we don't have a free market. There has never been a free market in the history of the world. But it's like you guys are condemning CEO and baseball player salaries, and then when some "free market" economist tries to defend them, you yell, So you don't like gold!! Sell out!! Bernanke shill!!!"
Published: January 22, 2007 3:07 PM
Those of Austrian background can always do well to question -- thank you Robert, for encouraging lively debate. I think perhaps the comments on this issue are not framed in the larger context beyond just the trade deficit.
My concerns with the trade deficit is that it is a necessity largely enabled by credit and currency unbacked by production, an inflationary environment only made worse by the inefficient tax and regulatory environment of the U.S. Without the trade deficit vent, we'd have been sunk long ago. Yet, the dislocative effects are more than theory, and long term the U.S. economy is wasting. Most recently we've been "investing" what we borrow into housing bubbles, fancy gadgets, and into a government ever more enamored with socialist experimentation and imperialism.
While foreign nations with the surpluses are miscalculating the sustainability of this deficit demand that will ultimately fall apart as part of the unwinding of basic Austrian Biz Cycle Theory, they at least will have the infrastructure to begin the recovery, while the U.S. citizens will be scratching their heads wondering what happened.
As for judging foreigners decisions, in a world awash with liquidity and unprecedentedly complex financial markets, I no more presume foreigners are correct in their valuation of U.S. assets at the moment than were investors correct about their valuations of the NASDAQ in 2000.
Oh, yes... and then there is the $4.6 trillion dollar real federal deficit when one applies GAAP and NPV of future obligations to the U.S. balance sheet. That number climbed from $3.5 billion last year, and implies long term financial insolvency for the U.S.
With each successive dollar of expanding credit generating less and less GDP, and the pace of inefficiency gaining momentum, clearly this is unsustainable. The trade deficit is merely a emblematic of these deeper problems that cannot last forever. The only question that remains IMO is the timing.
Published: January 22, 2007 3:11 PM
Hmm, is it just me or...,
I got lost on the shovel analogy. If the only product is shovels, and there isn't even any money (also in this analogy) and the shovels are identical, then why would any trade in shovels occur. Any trade besides N for N would mean one side loses, and even N for N would change nothing and involve transaction costs.
Before I read the rest, I need clarification on that issue.
Published: January 22, 2007 3:25 PM
I agree that this wasn't one Peter Schiff's best writings. He is often one of the best financial writers, although he is often too bearish. I certainly think he was wrong to seemingly imply that trade deficits are necessarily bad. To the extent that the capital inflow/current account deficits go to finance sound investments, it is definetly a good thing. I'm not sure that is exactly what he really thinks (sometimes one express oneself in a misleading manner), as he reportedly considers himself a libertarian and Austrian and who have explicitly argued against tariffs and other protectionists solutions to the trade deficit. His argument is that the trade deficit is ultimately the creation of Alan Greenspan and others in the Federal Reserve and federal government.
However, as I pointed out in my article on the subject, to the extent that it is caused by budget deficit or monetary driven asset price bubbles, it is a bad thing, as it will then go to finance consumption and malinvestments.
http://www.mises.org/Story/1762
Yancey Ward argues that all other governments inflate as much or more than the Fed, so therefore the trade deficit can't be the result of Fed inflating. But even apart from the fact that it's not really true that there aren't central banks that inflate less than the Fed , the point that he and apparently also Robert Murphy misses is that the important thing isn't so much the absolute level of monetary inflation, but the way it is generated. Different forms of money creation have very different effects on the trade deficits. Some increase it, some have a neutral effect and some reduce it.
As an example of the trade deficit reducing (or actually trade surplus increasing) form of money creation is the People's Bank of China massive accumulation of foreign exchange reserves combined with sterilization and administrative controls of bank lending. An example of trade deficit neutral form of money creation is when money is created and used to bid up prices of consumer goods, like for example hyper inflation in today's Zimbabwe. An example of trade deficit increasing form of money creation is when money is created and used to bid up asset prices, something which will both boost consumption and investments at the same time, which of course will imply a larger trade deficit.
The Fed have been pursuing the trade deficit increasing form of money creation, which is why it is misleading to overlook RPM and some other people do.
If, as RPM asks, money supply increases were halted, what would happen? Well, as ABCT teaches us that money supply increases artificially supresses interest rates, this means that interest rates would go up. Higher interest rates means that investments would fall as the present value of the returns of future earnings fall, and that savings would go up as there would be no wind fall earnings from asset price bubbles. The combination of lower investments and higher savings would mean a lower trade deficit.
This is re-inforced by the fact that central banks of certain Asian and oil exporting countries are pursuing trade surplus increasing forms of money creation, another source of distortion which should not be overlooked.
Published: January 22, 2007 3:52 PM
RPM,
With all due respect, Schiff was definitely NOT "condemning trade deficits per se," as he rails relentlessly against fiat currencies and decries trade deficits for this reason and this reason alone, knowing full well that you can't have trade deficits in a sound-money economy. Here's one of any number of examples:
http://www.safehaven.com/article-5812.htm
As for what would happen if "the Fed halted the money supply," etc., the dollar would obviously strengthen enormously, the effect of which would be to deal a severe blow to exports and vastly increase imports, thus exploding the trade deficit. That's why, despite his rhetoric, Henry Paulson wants a weak dollar, the better to promote exports and impede imports.
The problem, however, is that as the dollar weakens, foreigners -- especially foreign banks -- have less and less incentive to own them and thus less and less incentive to buy the US government debt that keeps the Ponzi going. And as I said above, once one of these banks goes for his gun (i.e., dumps their bond holdings), they all will. And the dollar will collapse, taking the US economy with it.
As for there never having been a free market "in the history of the world," I would say that as the ability of governments to intervene in the market was vastly less than it is today (being as centralized, fractional reserve banking is less than a century old), the world was a great deal closer to the free market ideal than it is now. (And I for one expect the digital gold -- e.g., http://goldmoney.com -- will one day bring us as close to the free market ideal as is humanly possible.)
Thus do I stand by all that I've said, reiterating my extreme disappointment that the Mises Institute chose to publish a piece attacking one of its own, and quite wrongly so at that.
Published: January 22, 2007 3:56 PM
David: "And as I said above, once one of these banks goes for his gun (i.e., dumps their bond holdings), they all will."
Why does the PRC collect dollars? Is it because they want to keep their yuan low so they can export more? So at why will they decide to commit economic suicide (at least in their minds, being confirmed mercantilists) and dump the dollars? If they dumped the dollars, the PRC would not be able to sell another Power Ranger to US children. Unemployment would sky rocket in the PRC. Economic growth would unwind faster than in our Great Depression. So what do you think will cause them to willingly commit such an act?
Published: January 22, 2007 5:07 PM
RogerM,
"Why does the PRC collect dollars? Is it because they want to keep their yuan low so they can export more?"
Yes, as stated above.
"So why will they decide to commit economic suicide (at least in their minds, being confirmed mercantilists) and dump the dollars?"
Some other country or countries (e.g., OPEC) may decide the issure for them by dumping THEIR dollars, but regardless, China knows that it can't keep piling dollars up ad infinitum and must find a way to get out from under them without crashing its own economy.
Whether it can do so remains to be seen, but as I said, a Ponzi is a Ponzi, and the longer the collapse of this one is delayed, the worse it will be.
Which is to say that in a fiat world, deficits DO matter. So protect yourself now, while gold and silver are still at fire sale prices.
Published: January 22, 2007 5:37 PM
The Balance of Payments (BP) has not two subaccounts (NX + CF = 0)but five:
NXG + NXS + TR + CF + dR = 0
Thus a negative trade balance in goods (NXG) can be compensated for by positives in either of the following subaccount: services (NXS), unilateral transfers (TR), capital imports (which would constitute a positive or credit in the account) and a change in foreign reserves. The trick is that the US cannot run out of foreign exchange because it can produce as much dollars as it wants (but it will be confronted with a price effect, i.e. lower dollar). On the other hand note the following: in the export surplus country, particularly China and some other East Asian countries, a positive NXG is not equally compensated for by negatives in other subaccounts other than the dR, i.e. the change of international reserves. Now here one must be careful, because an INCREASE in the foreign exchange reserves is registered as a NEGATIVE (or debit) in the balance of payments accounts. This is the situation that we are confronted with: the US can have any deficit it wants as long as some other entity (e.g. the Chinese central bank) buys the dollars and increases its foreign exchange reserve holding. If the Chinese central bank stops buying, the price effect sets it and the dollar sinks like a stone. If the Chinese central banks dumps its holdings of US notes and bonds, a financial markets crash will happen. One might also note that the services account (which includes interest payments) of the US is turning negative. The US also has a negative transfer account.
For more go to "www.continentaleconomics.com"
Published: January 22, 2007 5:40 PM
OK - I'll admit I still am down the evolutionary ladder on this economic stuff. But isn't there another dimension to this? I would agree that a simple investment choice by foreigners wouldn't make much difference in overall system. And if they bought BofA bonds or stock (private corporation) - then good luck to them.
But they aren't, they are buying obligations backed up by further taxes, and all the nastyness that represents. If, instead of bonds, these foreigners bought the ability to gas a subway of their choice, wouldn't that be objectionable?
I think most writers harp on the deficit, not because of the equations underlying it, but by the other elements it represents. Perhaps in this essay it may be declared a win by technicality - but it still leaves me far from satisfied.
Still looks an awful lot like a duck to me...
Published: January 22, 2007 7:47 PM
Stefan,
With all due respect, I think you are mistaken regarding the result of a halt to increases in the money supply.
Money supply increases tend to suppress interest rates only in the short term (when the new money first reaches the market). In the long term, increases in the money supply result in the addition of an inflation expectations component to the interest rate.
Given that, I think the rest of your conclusions are pretty much exactly backwards: interest rates would go down, and investment would increase. Savings IS investment, they don't go in opposite directions. All this would tend to result in a higher trade deficit.
Common sense seems to support this. Wouldn't you invest/save more if you knew the value of your principal wouldn't be eroded by inflation? (Hence the rush to consume in hyperinflations.)
Anyway, that would be the long-term view. The short-term seems more questionable, as there would have to be a (massive?) liquidation of malinvestment without the continuous creation of new money to support it.
Published: January 22, 2007 8:55 PM
OK you guys sucked me back in for another post...
DavidWhite: With all due respect, Schiff was definitely NOT "condemning trade deficits per se," as he rails relentlessly against fiat currencies and decries trade deficits for this reason and this reason alone, knowing full well that you can't have trade deficits in a sound-money economy.
That's a funny defense; it sounds like you're saying, "Rothbard didn't oppose taxation per se, he opposed theft." Two questions:
(1) When the US was on a gold/silver standard, did it ever have a trade deficit for more than 5 consecutive years?
(2) If all the nations of the world were all on gold, are you saying the current account balance would always be zero between any two pair of countries?
---
David White also posted this "good question" from a Bloomberg article:
"Last year, the Asian monetary authorities, together with the central banks and state investment agencies in oil-exporting countries, bought about $770 billion in foreign-currency assets. These official purchases financed most of the estimated $870 billion U.S. current-account deficit in 2006, according to research by the Federal Reserve Bank of New York. If the petrodollar surpluses dwindle, the job of sustaining U.S. consumption will fall squarely on the Asian central banks. Should the monetary authorities in China, Japan, South Korea and India continue to feed the American spending habit or invest their surpluses elsewhere?"
OK, are you saying that we are going to be in big trouble if the US stops spending so much on foreign oil? (It really seems that's what this quote is suggesting.) What if Americans stopped spending so much on Japanese electronic toys? Would that also worsen our trade deficit situation?
Published: January 22, 2007 9:08 PM
I can't believe there are 41 posts on this article. Anway, my two cents:
1) If foreigners accept dollars for their goods and don't ever use their new dollars to buy things in the United States, that seems like a pretty good deal (a free lunch) for anyone in the United States who received those foreign goods.
2) If foreigners buy US Treasury bonds (government debt instruments), I can agree that this isn't necessarily a good thing... but I am opposed to ANYone purchasing US Treasury bonds or other government debt instruments and so this is a seperate issue from trade and so-called trade balances.
Published: January 22, 2007 9:56 PM
Is there quick and easy answer as to what Henry Ford saw D. White? Especially when Henry was anti-Semitic and believe in the Jewish Conspiracy. It has been said that he was a believer in old-fashion hard work: what you did with your labour is how you paid. It has been said he didn't like Jews because they made money through paperwork not hard work. Was he complaining that debt can indeed be created out of thin air whereas equity has to be either created or traded?
Published: January 22, 2007 11:12 PM
I'm not an economist, I can't give any helpful insights in the controversy between mister Murphy and mister Schiff. However, I think I understand enough of both of them to realize it's a good idea to convert my (euro) savings into gold or silver. I found several ways on the web that enable me to do exactly that. Most prominent are Bullionvault.com and GoldMoney.com. Does anyone have any experience with these companies? Is it a safe way, as well as a sound idea, to use one of them?
Published: January 23, 2007 4:29 AM
GoldMoney is safe enough, but heavily bound up in the statist mentality - want too much private information before they'll let you open an account (esp. for companies), and they've closed down exchangers other than themselves, etc.; they don't seem to want people to use it as anything but a storage service (though (CEO James) Turk constantly claims otherwise). Don't know much about BullionVault.
My recommendations: pecunix.com (gold) and phoenixdollar.com (silver)
Published: January 23, 2007 4:44 AM
Catty Shaq doesn't have nice things to say about Pheonix dollar http://www.cattyshaq.com/forum/modules.php?name=Forums&file=viewtopic&t=1729&start=0&postdays=0&postorder=asc&highlight=&PHPSESSID=acceb1cdb857413f4c99a36d81b481e5
Does this reflect on Pecunix?
Published: January 23, 2007 7:08 AM
The Chinese Central Bank is printing yuan. That is bad. There are two things that can be down with this newly created yuan. Either it can be used to finance Chinese Communist spending or finance something else. The Chinese CB is choosing to finance US government spending in order to keep the exchange rate down. This is what is causing the trade deficit (for the most part).
Basically, the Chinese CB is stealing wealth from its population and using it to finance US government spending, just like the Federal Reserve steals from Americans.
Published: January 23, 2007 8:14 AM
RPM,
All I'm saying is that in a sound money economy, you can only borrow against savings, since by definition credit-based money doesn't exist. Thus, trade always balances out in that it's all a result of prior production. (And in fact what balances out isn't really trade between countries but the sum total of trade among all the various parties engaging in it.)
Not so in a credit-based monetary system, as the money is not a good that can be borrowed against. Thus, the debt it creates can only repaid with more debt. And given that the "dollar" (i.e., the irredeemable Federal Reserve Note) became the world's reserve currency when Nixon "closed the gold window," the world's other central banks have essentially had no choice but to hold it. And as we've moved from a save-to-produce economy to a borrow-to-consume economy (as Schiff writes elsewhere, "Both the public and private sectors borrow to consume, while the domestic economy lacks the savings or productive capacity necessary to support either." -- http://www.safehaven.com/article-6087.htm), we've forced those banks to hold ever larger amounts of our "dollars" in order to keep the consumption going. Result? A "trade deficit" that doesn't balance out with our capital account for the simple reason that the "capital" is almost exclusively debt. (Indeed, when other countries try to buy a tangible asset -- an oil company, for example -- we don't let them!)
Thus, my defense of Schiff isn't funny at all; it simply makes the distinction that was implicit in his article (based on so many explicit statements prior to it) that "trade deficits" are purely a function of our credit-based monetary system and wouldn't exist in a sound money system.
Published: January 23, 2007 9:03 AM
Sam, what Henry Ford actually said is, "It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning."
In other words, he wasn't complaining at all. Instead, even though he knew full well how fraudulent the system is, he wanted the American people to remain ignorant of it, the better for them to consume things (like cars) that they wouldn't otherwise be able to afford. This would have been highly inflationary had we not been able to essentially export it to cheap-labor countries like China. But once these countries have had their fill of our increasingly worthless "dollars," inflation will return with a vengeance -- i.e., as hyperinflation, even as the economy tanks.
Published: January 23, 2007 9:04 AM
Banker,
"Basically, the Chinese CB is stealing wealth from its population and using it to finance US government spending, just like the Federal Reserve steals from America."
Exactly, as this is what the fiat fraud is all about: theft.
Published: January 23, 2007 9:06 AM
Consider Murphy's comment:
"It is true that an inflow of capital represents growing liabilities to foreigners. But is this necessarily bad? After all, there should be a presumption of benignity to each individual transaction since it is voluntary."
Consider the following two economies, equal in all respects (including asset levels and composition) except except for international debt levels and thus net national wealth levels. In Economy A, past generations have, through current account deficits built up a net international indebtedness of 400, while Economy B has no foreign debt. (The net national wealth of Economy B is thus 400 higher than that of Economy A.) The people of Economy B are economically better off by 400. In income terms, supposing the annual debt service (in interest and dividend payments to foreigners) is 32, the annual gross national income (GNP) is 32 higher for the people of Economy B than it is for the people of Economy A.
Economy A's past generations, through their current account deficits, enjoyed a higher standard of living than did the past generations of Economy B. But the present generation of Economy B is now able to enjoy a higher standard of living than the present generation of Economy A.
Even though all individual decisions that led to Economy A's international indebtedness were voluntarily made by the past generations, they have saddled the present generation with a lower income level. And, as far as the present generation is concerned that situation was not voluntary to them. Consumption decisions are made more easily if one can spend other people's income.
Published: January 23, 2007 9:39 AM
Alex,
That's an interesting analogy, but it leaves out some important details. For example, if the two countries are exactly alike in all respects, why are they trading with each other? Theory says that they will trade only if one has an advantage in producing something over the other. If A has a trade deficit of 400, then that implies that B has an advantage in producing something over A. If B has an advantage, then A will enrich itself by purchasing from B rather than trying to make the thing itself. The savings will go into investment in new businesses and cause the economy to grow.
In addition, what happens with the counter balancing 400 in loans that pay for the 400 in merchandize? If the loans buy gov debt, then they lower the interest rate for businesses and spur investment, productivity and economic growth. If they buy corporate debt, they do the same thing more directly.
Look at Japan and Europe. Both have had longstanding trade surpluses with the US for over 50 years. Which citizens are richer?
Published: January 23, 2007 11:01 AM
David: "All I'm saying is that in a sound money economy, you can only borrow against savings, since by definition credit-based money doesn't exist. Thus, trade always balances out in that it's all a result of prior production."
It's simply not true that trade balances with sound money. You might try reading Ricardo, who wrote about trade under a gold standard. Or Reisman's treatment is easier to follow. Under a pure gold money system, trade frequently is unbalanced for long periods of time. The US ran a small trade deficit throughout the 1800s. It did so because foreigners saw such great opportunities to invest in the US that they shipped boat loads of gold and loans on gold to us, which resulted in a trade deficit.
What we should keep in mind here is that the US holds the top spot in the world for foreign direct investment; China is second. For many years China was first and the US second. Foreigners are desperate to invest in the US, as Pepe has pointed out above. How will they get the dollars to do so without selling us something, or selling something to someone else for dollars?
Published: January 23, 2007 11:10 AM
Assuming that Asian or Arab countries will suddently dump all of their dollars because they get scared assumes total irrationality on their part. Why would they do something so incredibly stupid? If Arabs are sitting on trillions of dollars from the sale of oil, what would the get out of dumping their dollars? Assuming they sell dollars for euros, the exchange rate for the dollar would fall further with each sale. When the market discovered what the Arabs were attempting, they would offer even less for the dollars. Eventually, Arabs would have to sell the dollars for less than a cent. Please, somebody explain to me why they would be so stupid?
Published: January 23, 2007 11:21 AM
A comment for all of the gloom and doomers: If there is in fact a total collapse of the dollar do to it being a ponzi scheme, that does not neccessarily mean a collapse in the world economy. The dollar is just a medium of exchange. The economy, your house, your car, etc. are all real goods.
What will happen in a collapse of the dollar is that everyone who is owed dollars will be up sh*ts creek.
Thankfully, we are the ower, not the owee.
If you think that the dollar is going to collapse, now is the perfect time to take a 100% mortgage on a big house, etc.
Published: January 23, 2007 11:56 AM
I rather doubt that people "investing" in government debt is good for the United States.
If Chinese institutions (such as banks) choose to buy United States government debt this does not really "pay for" the importation of Chinese goods.
Nor does "investment" in consumer debt.
One might as well say "I have bought a new car on credit - but it is O.K. because I have a positive capital inflow from a credit company which balances my outflow of money for the car".
There is no long term subsitute for the production of goods and services.
"Consumer demand" (or government demand) is NOT "what the economy is based on" - production is what the economy is based on.
Or - J.B. Say yes. J.M. Keynes no.
Published: January 23, 2007 12:18 PM
Roger M:
These are not two countries trading with each other. And the 400 is not a trade deficit (or, more accurately, a current account deficit); it is the outstanding level of international debt accumulated from past current account deficits. Think of A and B as two alternative situations that a single country could be in, with two different past spending choices. In situation A, the country has spent in aggregate more than its income for many years (i.e., run trade deficits for many years), while in situation B the country has in the past had current account balances of zero. In situation B the present population would have a higher aggregate annual income (or in present value terms, higher aggregate wealth).
Published: January 23, 2007 12:54 PM
Sorry, I forgot to reinforce the main point I am trying to make. When a country runs current account deficits and build up net foreign debt, future generations, whose income is reduced, do not have any input to these past spending choices and hence cannot be said to have voluntarily chosen this net foreign liability, lower wealth, or lower income.
Published: January 23, 2007 1:00 PM
Sorry, I forgot to reinforce the main point I am trying to make. When a country runs current account deficits and builds up net foreign debt, future generations, whose income is reduced, do not have any input to these past spending choices and hence cannot be said to have voluntarily chosen this net foreign liability, lower wealth, or lower income.
Published: January 23, 2007 1:01 PM
Boy this is addictive...
Alex: First, you rigged the example by assuming that the trade deficits were due to consumption. In general that need not be true. If Country A ends up with a huge accumulated "debt" because it imported a bunch of tractor trailers, locomotives, supercomputers, etc. from foreign savers, its people won't necessarily have a lower standard of living than those in Country B.
Second, since when do libertarians argue that previous generations owed us something? Yeah, I'd be richer if my grandparents didn't eat so much steak. So what?
Now I _know_, people are going to come back and tell me that the current situation is due to gov't coercion and isn't the outcome of free choices. That's true, but most of the comments on this blog (as well as the Schiff piece that I critiqued) are making blanket statements.
----------------------
David White: All I'm saying is that in a sound money economy, you can only borrow against savings, since by definition credit-based money doesn't exist. Thus, trade always balances out in that it's all a result of prior production.
So David, under the gold standard can a salaried worker get a mortgage from the bank in order to buy a house? In your zeal to criticize central banking and fiat money, you are saying that debt itself is illegitimate.
Published: January 23, 2007 1:11 PM
Wow. Alot of, let's say interesting, analysis here.
First off, let's state the obvious, so that we can agree on a premise. Fiat money inflation, at least in excess of 3%/year, is a bad thing. Are we all together on that? Good.
Now, the Fed's been consistently overshooting that for a while now. One would expect dire consequences to arise from the imbalance. In essence, this excess inflation has led Americans to believe that they have more savings than they actually have (and no, investments are not an identity with savings - investments are a use for savings). In response to this objectively wrong belief, Americans have engaged in all sorts of overspending, falsely confident in their savings.
Normally, such overspending eventually leads to inflation (hyper- or not). Yet the United States has not seen this back-end of the Austrian Business Cycle - why not? Well, because the Euro-zone and Asia are currently inflating away their people's savings in order to prop up their mercantilist empires. As an initial matter, we should be very careful about speaking about this arbitrage as "voluntary" - when done by individuals, it is. When done by states and their central banks, it is not.
Next, we shouldn't cheer or even be happy that these foreign governments are screwing their people royally for the benefit of their mercantilist masters and incidentally our benefit. This is evil, pure and simple. Just because you benefit from the evil committed by another state on its citizens doesn't turn the evil into a benign activity.
Morever, this involuntary wealth transfer prevents a corrective mechanism from occuring. Namely, in the absence of foreign inflation, the U.S. would be feeling the effects of its own inflation. This would act to apprise the U.S. consumer of the reality of his savings account - that it is less (in real terms) than he thinks it is. U.S. consumers will cut back on consumption, begin to plan rationally on what future needs need to be saved for, and follow the plan.
As for what would happen if the U.S. stopped inflating? It's silly to think these other governments and central banks would continue - they've been inflating specifically to keep pace with the U.S. in order to maintain the current trade balance. If the U.S. stops, they stop. The involuntary wealth transfer in these countries (through inflation) stops. Good result all around. Their citizens will enjoy (absent other state interventions) an increase in their standard of living as they reap the full benefit of their trade (without mercantilist fat-cats skimming off the top). Soon, it will become favorable to outsource labor to the United States, where labor will be more desperate, and be willing to accept lower wages than it is in these suddenly more wealthy countries. The trade balance will eventually move back towards equilibrium.
Finally, as to who would be so irrational as to kick over the house of cards? Well, someone on the outside, looking in - like an Iran/Russia alliance. Furthermore, we're talking about states here - do we really believe that they always act rationally? Remember - as objectively irrational as people act in overvaluing assets in a bubble top, they will be equally objectively irrational in undervaluing them in the bust. The business cycle is fundamentally economic in origin, but secondary, psychological factors dominate in the extreme stages. A series of cascading cross defaults in private equity or hedge funds could cause the sell-off without any single state making the conscious decision.
Published: January 23, 2007 1:21 PM
"So David, under the gold standard can a salaried worker get a mortgage from the bank in order to buy a house? In your zeal to criticize central banking and fiat money, you are saying that debt itself is illegitimate."
Speaking for David, I'd say you are mischaracterizing his argument. David is merely arguing that under sound money, all credit is based on prior production. Debt is still legitimate, as the debtor need not have engaged in prior production. Rather, the lender must have, or at the least obtained the loan proceeds from someone who had.
So yes, the worker can get a mortgage. But the bank would either have to get the funds from prior production or as a gift from someone who had engaged in prior production. It couldn't just magically create the funds through the wonders of FRB.
Published: January 23, 2007 1:31 PM
RPM:
No, I absolutely DO NOT assume in my example that the current account deficits were the result of consumption and not real investment. My example is totally independent of whatever type of spending it was that resulted in a 400 level of international indebtedness accumulating in situation (or Economy) "A".
The physical assets in both countries are identical. They both have the same number of locomotives, etc. The only difference is that the domestic saving used to finance this asset accumulation was higher in B than in A.
In this situation, you cannot claim that the foreign debt is of no consequence to the present population of A. The population of B has a higher aggregate income than does the population of A.
Nor can you claim that all parties to the resulting present economic situation (e.g., with 400 net foreign debt for (the people of) A) have placed themselves in this situation by their voluntary market decision making. (This is the important point.) The present population was not in on the decision making concerning the net international debt.
Published: January 23, 2007 1:53 PM
A return to sound money is a return to the historical past when 50% of the population lived in real poverty and were a part of the 80% of the population who were working poor, with maybe 15% middle class doctors, lawyers, and shop owners and 5% stinking rich.
Why do Libertarians think that a return to a gold standard would put them in the top income brackets?
Published: January 23, 2007 2:06 PM
By billwald's reasoning people during middle-ages were poor because they didnt have inflationary central bank to drop "helicopter money" to the people.
Present wealth is created by the greater productivity of factors and not any inflationary currency. Common sense should tell that.
Published: January 23, 2007 2:15 PM
I agree with billwald. "During" implies "because". Duh.
Published: January 23, 2007 2:28 PM
Alex: "These are not two countries trading with each other. And the 400 is not a trade deficit (or, more accurately, a current account deficit); it is the outstanding level of international debt accumulated from past current account deficits."
That's what I assumed you meant. My previous analysis still holds. Though the current generation owes 400 to foreigners for past trade deficits, they are wealthier today than they would have been trying to balance trade. One reason I can make such a statement is that we must assume that the previous generations weren't complete idiots; they bought foreign products because they were a better value than domestic ones. Previous generations benefited from the imports. In addition, the 400 that previous generations spent on imports eventually came back to A when B bought A's stocks and bonds. So not only did A benefit from the imports, from from the subsequent investment as well.
Published: January 23, 2007 3:58 PM
billwald: "Furthermore, we're talking about states here - do we really believe that they always act rationally?"
The problem with assuming that people will act irrationally is that it destroys economics, not only as a science, but as a topic of discussion. It also assumes that people don't know their own self-interests or how to meet them. If that's true, then anything is possible and likely, so there's no use even discussing it and everything Mises wrote is backwards.
Published: January 23, 2007 4:09 PM
Speaking for David, I'd say you are mischaracterizing his argument. David is merely arguing that under sound money, all credit is based on prior production.
This statement is either true for both sound and fiat regimes, or it is false in both. If by "based on prior production," you mean that something tangible had to have been previously produced in order to be lent, then it is true for both. If by "based on prior production" you mean that the borrower has to borrow against existing assets, then it is false in both.
Right now Americans are able to get real TVs, computers, cars, etc. that foreigners actually produced. Those are real, physical goods. Part of the payment for them is promising a portion of future income earned by Americans.
Under a pure gold standard, a salaried worker can get a real, physical house now, in exchange for promising portions of his future paycheck. He might have had no savings at all to that point.
Yes, fiat currency is bad and the gold standard would be much, much better. But you guys are still making sweeping statements about the "trade deficit" that are false.
The US had a trade deficit for at least 100 years when it was on a gold standard. (I'm not saying consecutively, necessarily.) It is perfectly "sustainable." It seems counterintuitive but that's the problem with a misleading term like "trade deficit."
Published: January 23, 2007 4:42 PM
RPM (and RogerM),
In a sound-money, free-market economy, political boundaries don't matter. All that matters is that the parties within those boundaries are free to trade within and across them, the sole purpose of which is mutual advantage, else no trade would take place: I want what you've got; you want what I've got; we agree on a price -- i.e., on an amount of whatever good is used as the medium of exchange -- and a trade takes place. As there is no "deficit" in such a transaction (unless one party defrauds the other), neither is there a "deficit" in the sum total thereof.
As for the accusation that I believe "debt itself is illegitimate," I assumed quasibill had put that one to rest, but obviously not, and I am frankly astounded by your reply. For a fiat monetary system creates money via the issuance of credit that has no goods backing it up. That is, unlike in a sound-money system, THERE IS NO PRIOR PRODUCTION OF A GOOD THAT CAN THEN BE LENT. Thus, the borrow is absolutely NOT borrowing "against existing assets." And as the debt in such a system can only be repaid with the same instrument that created it -- i.e., "legal tender" -- it can only be repaid with the of issuance of more credit, and thus more debt, ad infinitum.
Lastly, whatever "blanket statements" Schiff might have made in the article in question, they are predicated on his very principled -- i.e., Austrian -- stance on the matter of money and the corruption thereof, the latter bearing sole responsibility for "trade deficits" and the very serious problems we face on account of them. So while you are welcome to call him a "doomsayer," he is in reality a truth-sayer, the only question being when the truth has its final say on the matter.
Published: January 23, 2007 5:21 PM
I see that RPM and Yancey Ward have so far simply ignored my arguments. Which I must interpret as a sign of inability to answer them, i.e. a implicit admission that I'm right. If not, I challenge them to answer my arguments.
As for Ragnar's point about the inflation premium on interest rates through government inflating, it is irrelevant for this issue. Investment decisions are based on real interest rates, and that won't adversely be affected by any inflation premium.
Published: January 23, 2007 5:23 PM
RogerM:
Yes, people buy imports because they get from them more bang for the buck than from domestic goods. That's rational, and domestic welfare enhancing behavior. But the fact that comparative advantage leads us to buy imports has absolutely nothing to do with current account (or trade) deficits.
Suppose international financial investment flows were prohibited. There is no foreign lending or borrowing of any kind. In such a situation, the only way to access foreign exchange to buy imports would be from the proceeds of export sales, and the annual current account would always balance. (Obviously, there can't be any current account deficits if there can't be any capital account surpluses.) Comparative advantage incentives would still be operative and people would be importing the goods they wanted and exporting the goods other nations wanted.
Now, when international capital flows are permitted, not only is comparative advantage at work determining what we export and what we import, but a mechanism now exists to allow a country in aggregate to choose how much to spend on imports. No longer are import purchases in aggregate restricted to the level of export sales. When a country imports more than it exports and runs a current account deficit (and correspondingly a capital account surplus), it means that, in aggregate, the domestic population's spending in a given year, in total, on consumption-type goods and investment type goods (and services), exceeds its income. Other countries will also be exporting and importing according to comparative advantage and running current account surpluses due to the aggregate spending and saving actions of individuals, businesses and governments.
Current account deficits (capital account surpluses) result from aggregate spending in a country exceeding aggregate income (and all these spending decisions might have been carefully considered and made voluntarily by individuals either as consumers, as decision makers in businesses, or as individuals in government).
If a country has a net foreign debt of 400 (as in my previous example), and the asset base is exactly the same as it would be with no net foreign debt, the net foreign debt makes the current population worse off than it otherwise would have been. For this not to be the case, it must be argued that the acquisition of the foreign debt has permitted the asset base to be 400 higher than it otherwise would have been. Or (which is equivalent), that the foreign debt has allowed enough additional profitable investment to take place such that the annual income generated from the investment is enough to provide for the annual foreign debt service. Now, is there anyone here that would argue that this is the situation with the U.S. net foreign debt today? Even if this situation were true, the American population, if given the choice concerning past spending, investment and saving decisions (which choice, of course, is impossible) would voluntarily choose higher levels of domestic saving in past years, so that the level of net foreign debt would now not be so high and their current incomes would be higher.
Published: January 23, 2007 5:34 PM
"Suppose the U.S. military adventure in Iraq, conceived in lies, had to be financed with war taxes on current voters instead of borrowing from foreigners, borrowing that will be repaid by future generations who will have had no say in the debt incurred in their name. Without infinite money, money borrowed against the future, the adventure in Iraq would not have been undertaken. ... And suppose the world's main reserve currency was not under the control of a single nation and thus was not a weapon of imperial power as well as a threat of expropriation of those who have trusted in it. Suppose the world's main reserve currency was something international of independent and enduring value. Then no nation could lord it over any other nation."
http://www.gata.org/node/4733
Moreover, no government could lord it over its own citizens by, among other things, robbing them blind with "infinite money."
Published: January 23, 2007 6:02 PM
Catty Shaq doesn't have nice things to say about Pheonix dollar
Does this reflect on Pecunix?
They're not related. But AFAICT, it doesn't even reflect on the Phoenix Dollar - they're talking about selling 1oz coins for $250, but see here for PxD pricing: 1oz rounds are between $0.50 and $0.75 over the current bulk silver ask, depending on how many you want. (If you know a cheaper source of silver rounds and bars, please let me know!). There's a "founder's account" (low account number) that costs $250, and you get a special 1oz round when you buy one, but you're not paying $250 for an ounce of silver, you're buying the low account number (and no acct fees for life, I think) - don't buy that if you don't want it.
Published: January 23, 2007 7:14 PM
David White: I want what you've got; you want what I've got; we agree on a price -- i.e., on an amount of whatever good is used as the medium of exchange -- and a trade takes place. As there is no "deficit" in such a transaction (unless one party defrauds the other), neither is there a "deficit" in the sum total thereof.
David, there's no way for me to say this politely. You are using a different definition of the term "trade deficit." If you are right, it would have been impossible to have a trade deficit in the US before 1900, right? So are you agreeing that if we looked up the trade stats, the balance would be exactly zero up until the US went off gold?
You're right, the overall trade accounts _do_ balance, but that's because a current account deficit can be offset by a capital account surplus. With two 100% an-cap regions, if the people in A are net investors vis-a-vis the people in B, then there would be a trade deficit between the two groups.
Again, I'm not saying our current situation must therefore be fine, I'm just trying to get you to realize you are making false claims about trade deficits.
--------
Stefan, I'm not sure which claims you mean. If you are saying that the government keeps real yields permanently lower through its printing of money, I say you are wrong. If the Fed credibly promised never to print another dollar bill, there would be tons of net foreign investment in US assets, i.e. current account deficit would go way up.
Published: January 23, 2007 8:21 PM
"If by "based on prior production," you mean that something tangible had to have been previously produced in order to be lent, then it is true for both."
Okay, I'm going to print $500,000,000.00 and "lend" it to you. Shew, in your world, it's all backed up with prior production!!!
It's a socialist paradise - Marx was right!
The reality, that you ignored in my previous post, is that the value of the dollars used in international trade is set by the confluence of state policies. Chinese laborers are being robbed of their rightful profit through this confluence at the same time that U.S. savers are being robbed of their savings.
I do recognize, and thought it was clear, that the current trade deficit is an effect, and not a cause. But that doesn't mean it is some neutral or benign sign, either. It's a symptom of a very evil, very unstable economic system. And such unstable systems, while they can persist for quite a long time, always get blindsided and collapse. The longer they persist, the more they pervert culture and common knowledge, sometimes to the point where, like a cancerous tumor, they can kill the host culture.
Roger,
"The problem with assuming that people will act irrationally is that it destroys economics, not only as a science, but as a topic of discussion"
Nice try at introducing a strawman, but try reading what I said again - hint - I said nothing about "people". And even then, one can allow for the fact that in certain circumstances, people will act in an objectively irrational manner because of imperfect knowledge. It's what we in the hard sciences called a margin of error.
Published: January 24, 2007 7:53 AM
The ratio of total export prices to total import prices should be distinguished from the "objective" value of the dollar. I can't see that a different ratio of exports to imports would *necessarily* affect the purchasing power of the dollar. Fed policies that may potentially destabalize the dollar and US government bond sales may certainly do this, but (and I may be wrong about this) I don't think loans or bond sales factor into calculating the trade deficit.
Published: January 24, 2007 8:22 AM
Alex: "When a country imports more than it exports and runs a current account deficit (and correspondingly a capital account surplus), it means that, in aggregate, the domestic population's spending in a given year, in total, on consumption-type goods and investment type goods (and services), exceeds its income.
I think I see the problem. You're right that a trade deficit means that a country consumes more than it produces, but only with regard to international trade. Exports aren't the income of a nation; in fact, exports are a small part of the income of most nations, the US particularly. The US grows primarily from internal investment, specialization and productivity increases. If we had no imports/exports at all, we would continue to grow economically.
Which points to another problem with the national accounting system; it assumes that nations are businesses that prosper or fail according to their international trade position. The creator of this accounting system (I believe it was Kuznets) intended us to view it that way because he was a socialist and a mercantilist. But it's exactly the opposite of how we should view international trade. We should see it as the same thing as private trade, for example as the relationship of my household to Wal-Mart. I have a huge trade deficit with Wal-Mart because Wal-Mart never buys anything from me. So why do I continue to trade with Wal-Mart? Because Wal-Mart sells things cheaper than I can make them myself. As a result, I have more money left over to buy other things, or save, which makes me richer than if I didn't trade with Wal-Mart and tried to make those things myself.
quasibill: "Nice try at introducing a strawman, but try reading what I said again - hint - I said nothing about "people".
So, the governments you mentioned are run by computers or aliens?
Published: January 24, 2007 8:31 AM
As I understand Dr. Murphy's article it goes like this:
1. He is for the war on drugs therefore believes in fiat currencies and is against the gold standard.
2. His algebra is the equivalent of witch-craft
3. His Doctorate in economics was paid for with fiat money and therefore the the knowledge he gained is false i.e. based on a fraud.
Am I close?
p.s. He is also a Keynesian, Marxist or both and has been known to be a thespian and practices nepotism with his female cousin.
Published: January 24, 2007 8:51 AM
"So, the governments you mentioned are run by computers or aliens?"
No, by human beings who aren't held to the same standards of accountability that normal people are, and so do not act in accordance with objective rational thought. See, e.g., Hitler, Stalin, Clinton, GWB...
Try again.
Published: January 24, 2007 9:40 AM
i dont understand - need some analysis of the mechanism - there's not much voluntary about 3rd world citizens being screwed because a dictator went into debt, blew up the economy, and the next guy is forced to buy and hold treasuries.
and structural changes do make a diff. if i've spend the last 30 yrs developing train technology on the flow of credit and suddenly the market collapses, that's not an 'adjustment' ... it's catastrophe.
and further, if i'm well connected to the u.s. central bank, and i can dilute the share of production (money) for the world by issuing credit and backplay the systemic hazard card, there's really no end to what i can finance at other people's cost ... and i get all the gain when it pans out .....
i thought austrians made heterogeneous 'structural' arguments - which is what really matters.
Published: January 24, 2007 10:37 AM
quasibill: "No, by human beings who aren't held to the same standards of accountability that normal people are, and so do not act in accordance with objective rational thought. See, e.g., Hitler, Stalin, Clinton, GWB..."
OK, I get it. All political figures (I assume you include central bankers) are evil and insane, so we can only expect the worst from them. Of course, if they're truly insane, doesn't that absolve them from being evil?
Published: January 24, 2007 10:50 AM
Pepe, Unfortunately I think a lot of people will miss the sarcasm. I agree with you point. It's hard to discuss economics with people as obsessed with fiat currencies as some people are. It seems that fiat currencies are the root of all evil for some. I think what Murphy is trying to get across is that fiat currencies don't cause trade deficits or surpluses, even though they can contribute to them. The evidence is clear from the century in which we used gold and silver as currencies.
Published: January 24, 2007 10:54 AM
RogerM: You said
"...a trade deficit means that a country consumes more than it produces, but only with regard to international trade."
No, a current account deficit means that a country's population in the aggregate spends (on consumption and investment type goods and services) more than its aggregate income from all sources. The easiest way to see this is as follows. Suppose (and this is just for numerical simplicity), that exports have always equalled imports and therefore a country's net international debt is zero. Further, also for numerical simplicity, suppose the remuneration paid non-residents for work done in the domestic country is the same figure as the remuneration paid to domestic citizens for work abroad. If the country's production (GDP) in the year is 100, this would also be the GNP or, in other words, the total income of the domestic population.
Now, total domestic plus foreign spending on domestic production must equal 100 because that is what is produced. (Remember, any unbought domestic goods production is part of domestic inventory investment, that is, part of domestic spending on currently produced goods.) Let us say, that foreign spending on domestic production (exports) is 20. Domestic spending on domestic production must therefore be 80. A current account balance of zero implies that domestic spending on foreign goods and services is the same as exports, that is, 20. Therefore, total domestic spending on all currently produced goods and services =80 + 20=100. Aggregate domestic spending = aggregate income.
Now, leaving the above numbers unchanged except for higher imports of, say, 30 (meaning a current account deficit of 10; 20 exports, 30 imports), total domestic spending=80 (on domestic g&s) + 30 (on foreign g&s)=110, which is in excess of domestic income (100) by 10. Try any other numbers you like, the current account deficit always represents the amount of domestic spending on currently produced goods and services in excess of domestic income.
Published: January 24, 2007 11:11 AM
Imagine that a group of settlers find an island which has many unclaimed natural resources. These settlers know that by having capital goods in their disposal they could quickly convert these resources into productive use.
Leader of settlers says: "We can loan gold from our native country and promise them to pay back everything plus interest after some time. By using this gold to buy capital goods we can quickly make us and our descendants wealthy."
One opponent says: "By now taking huge loan we will force our children into debt slavery since they would inherit at leat some of our debts since some investment projects are so long lived that we wont see them producing anything."
Leader responds: "That might be true, but they wouldnt even have so much capital at their disposal if we are forced to save for everything and not use international capital markets."
Published: January 24, 2007 11:11 AM
Alex: "No, a current account deficit means that a country's population in the aggregate spends (on consumption and investment type goods and services) more than its aggregate income from all sources."
Now you've changed the argument to include investment. I was talking about consumption only. I would agree with you that a trade deficit indicates higher investment and consumption, but not consumption only.
But as Adi points out, higher investment is a good thing; it means higher levels of consumption in the future.
Still, you're using the national accounting system to prove the national accounting system. I agree that the system accounts for cash flows well, but has no relationship to the wealth of a country in the present or the future. Your example is a snap shot in time that doesn't allow for the effects of the increased imports.
For example, you mention in your example that imports jump 10 to a total of 30. Why? If it's because they can purchase the same goods for less, then Americans are wealthier, even though cash income of 100 hasn't changed. In other words, their income of 100 will go farther, buy more, than it did before, which is the same as an increase in income. In addition, the money saved on the imported goods will go toward increased spending/savings in the US.
Finally, the result of the increased imports will be foreigners with extra dollars that they don't have to spend on US exports. So they'll spend them by investing in US stocks and bonds and thus create jobs and boost production in the US by the amount of the deficit, 10.
Your analysis suffers from the lack of a time element and too high of a level of aggregation. This is what Mises and Hayek constantly warned against.
Published: January 24, 2007 11:37 AM
There are obviously different economic and moral consequences to borrowing money to create infrastructure and borrowing money to buy toys and kill to people in foreign nations.
Published: January 24, 2007 11:43 AM
Adi:
Let's look at two end-of-spectrum scenarios with your island group.
1. The island is abundant with other easily acquired wealth. Coconuts, fish, pearls. This wealth is such that combined with trade, the settlers will soon be living in the lap of luxury. Except, the pearls will only last the lifetime of the present settlers. Same thing with the fish and coconuts. Even though the capital goods to exploit the other resources could easily be financed from the proceeds of exports sales of the pearls, coconuts and fish, the leader knows that's a hard sell to the settlers, who would prefer the high life. After all, what has the next generation done for these settlers lately?
2. There are enough other resources (other than the ones that require capital goods to exploit) on the island that, with hard work, the settlers can only provide themselves with a subsistence living.
Case 2. is a no-brainer. Borrow to finance the exploitation of the long lived resources if the yield from the resource exploitation exceeds the interest rate. The next generation's net wealth will be higher than otherwise.
Case 1. In this case, the leader's response could be legitimately challenged. Another settler could argue that there would be a relatively small standard of living sacrifice of the present generation for the sake of a higher than otherwise standard of living for the future generation. In case 1., what would the future generation (after all, these people are affected by the present saving-investment decision) prefer if they were able to express their choice.
The real world U.S. lies between Cases 1 and 2, but the future generation would probably argue that the U.S. is closer to Case 1 than Case 2. In any case, the argument that all market decisions voluntarily made by present decision makers are at worst benign is false since not all those people who are affected by the decisions get to input on those decisions. And this is the case for intergenerational decisions. The present generation will opt for a higher level of present consumption-type spending than would be the case if they had to pay the full cost and were not able to push some of the costs on to the next generation. How would your spending decisions be affected if I let you use my credit card?
Published: January 24, 2007 11:46 AM
Alex, it would sound strange if I would complain to my parents that they have consumed so much that my inheritance will be diminished. It's logical from my point of view, but not necessarily ethical...
Each generation can use only those resources which they own or against which they can get loans.
Published: January 24, 2007 12:07 PM
RogerM
My argument has nothing to do with the national accounting system. I used the terms GDP and GNP because they are concrete concepts.
There could be many reasons why a country begins to import more than it exports, but the bottom line is that if it does, the population, through the aggregate of all individual decisions as households, businesses, or governments are spending more on consumption-type and investment-type goods and services than the aggregate of the population's income. And, it doesn't matter who wants to do the addition (national income accountants or artists) or the words that they use.
Re: investment, see my response to Adi.
Here's the time element. Over the years, current account deficits lead to higher levels of net international debt. Higher levels of net international debt require higher levels of servicing (higher interest and dividend flows to foreigners) and lower income for the domestic population.
Here's the argument at the individual level. Individuals (buyers, sellers, lenders, investors) make voluntary rational choices (decisions) that benefit themselves. These choices (decisions) are benign to others if others' lives are unaffected by these choices (decisions). However, if other people's lives are affected, one cannot say that all individual rational choices (all free market transactions) are always beneficial (or at worst benign) to all concerned (to all affected by the decision).
Published: January 24, 2007 12:11 PM
Adi: Geez I have to get lunch.
It would be very strange and embarrassing if you were to complain to your parents that if they had spent less on themselves your inheritance would be larger. However, your complaint would be true. It's a tricky question for parents concerning present spending vs. leaving a larger inheritance. And it's tricky because it is a real issue. Parents know that the more they spend the less their beneficiaries will inherit.
You are right that each generation can only use those resources that they own or borrow. And when they borrow, they are using the next generation's resources. So the choice is spend by using this generation's resources or the next generation's resources.
Published: January 24, 2007 12:19 PM
Alex: "My argument has nothing to do with the national accounting system. I used the terms GDP and GNP because they are concrete concepts."
It's the same type of cash flow accounting used by the faulty national accounts.
"the bottom line is that if it does, the population.. are spending more on consumption-type and investment-type goods and services than the aggregate of the population's income."
I already agreed with you on this. I was just pointing out that you changed the argument when you added investments to consumption. If a country spends more on investments than it earns, isn't that a good thing, even if it borrows from foreigners? It is a good thing as long as the investment can pay back the interest due and leave some profit for expansion.
"Higher levels of net international debt require higher levels of servicing (higher interest and dividend flows to foreigners) and lower income for the domestic population."
The first part is right, the second is wrong. High levels of international debt come from foreigners investing in the US. Investment creates jobs and new wealth. So higher levels of international debt requires higher levels of income for the domestic population.
"And when they borrow, they are using the next generation's resources."
That's true of consumption only. If the borrowing is for investment, then we're increasing resources available to future generations.
Published: January 24, 2007 12:47 PM
Shew, RogerM, you just can't help but mischaracterize arguments, can you?
R E A D carefully what I wrote. Did I ever say the words "all" or "every" like you're arguing against? At least try to respond the argument I make, instead of the argument you want to hear.
Try again to avoid the point - I know you will, because you can't counter it. I anxiously await your next attempt at question begging.
As for the history that you and RPM point to - don't forget context. What was happening in North America at the time the such imbalances were occuring? Points off if you think it had anything to do with free trade. Hint, *Trail of Tears* and *3/5 compromise*.
Of course capital will flow in when stolen goods are being sold. Once again, if you're willing to ignore violations of private property rights when you're talking about the "free market", you and I are talking about two different things.
Published: January 24, 2007 1:30 PM
Investment may not be consumption, but it isn't the same thing as savings, either. Investments only increase future wealth if they are *good* investments. And it shouldn't need to be said that not all investments are good investments, especially investments made by states.
Borrowing to fund the investment to create a business that goes bankrupt in one year does not increase the borrower's wealth in any way. And it may not increase the lender's wealth, either. In which case, it is best characterized as consumption.
On the other hand, a successful investment that is leveraged can increase wealth, and the borrowed capital could be seen as a form of savings.
But it's clear that its true nature is contingent. And that is what entrepreneurship is all about - making the decisions that end up in increased wealth more often than not. The problem with inflationary cycles is that it deludes people into thinking that they have more savings than they actually have, and therefore the demand for investments is artificially increased, leading to more bad investments (as the number of solid opportunities remains relatively constant in the given time period) - but, as long as the inflation continues unabated, even bad investments will make money through speculation, for a while. Which just introduces more risk pollution, creating even worse investments.
Meanwhile, a side effect of this believe in savings that don't actually exist is that people feel that they can safely spend more than they earn. This psyhological factor manifests itself in many symptoms, one of which is a persistent, increasing (note, there is a HUGE difference between a deficit that hovers around an equilibrium zone and is chopped up by frequent surpluses and one that is persistent and constantly increasing) trade deficit: people are spending their savings because they perceive their savings to be large. When price inflation catches up, however, that's when they realize that they overestimated what their savings were.
This stuff is real, real, basic ABCT. It's amazing that people on this site don't seem to understand it.
Published: January 24, 2007 1:43 PM
quasibill: As for the history that you and RPM point to - don't forget context. What was happening in North America at the time the such imbalances were occuring? Points off if you think it had anything to do with free trade. Hint, *Trail of Tears* and *3/5 compromise*.
Thank you for at least acknowledging that there were trade deficits even when the US was on a hard money standard.
But I'm still confused. If a thief steals my TV and sells it to a Chinese person, that somehow makes the trade deficit go up?
David Wright: Do you agree with quasibill's move? I.e. he admits that there were official "trade deficits" before 1900 in the US, but that they were due to thievery. Do you agree with him, or do you still maintain that there can't be a trade deficit unless there is a fiat currency?
Published: January 24, 2007 2:09 PM
Oh, let me try to eliminate one round of back-and-forth... I imagine quasibill will say, "Can't you read? The Chinese gov't steals from its people and sells the stuff to us, and that's why the trade deficit is so high."
So I'm saying, because US thieves in the 1800s stole land from Native Americans and labor from black slaves, how does that explain the trade deficit of the US at that time? Shouldn't you have been pointing to the guillotine or something to explain the trade deficit for the US?
Published: January 24, 2007 2:17 PM
quasibill: "R E A D carefully what I wrote. Did I ever say the words "all" or "every" like you're arguing against?"
OK, so you'll have to tell me which ones are insane and which ones aren't because I can't tell.
"This psyhological factor manifests itself in many symptoms, one of which is a persistent, increasing ... trade deficit: people are spending their savings because they perceive their savings to be large."
I don't have any disagreement with this. But I would add that investment offsets consumption. Americans don't borrow from foreigners in order to consume more than they earn. It only looks that way when you aggregate everything to a high level, as Alex has been doing. Americans pay cash for imports. Afterwards, foreigners decide to buy some American goods and invest some dollars in the US. Not all investments will succeed, but some will succeed far beyond the expectations of the investors. Foreign investment is the flip side of domestic borrowing (except for foreign direct investment). So if you conflate time, then it appears that we're borrowing to consume, but that's the wrong way to look at it. It would be more accurate to say that Americans don't save enough, so American businesses (and the gov) borrow from foreigners in order to produce more. Such borrowing, and investment, increases production, wealth and consumption in the future. This borrowing causes the trade deficit because foreigners need dollars to lend to us. Even Keynes recognized that process.
The problem with the national accounts, and Alex's example, is that both are simple cash flow statements. All that cash flow statements tell us is where money came from and where it went, not how it was used. In order to determine the effects of those cash flows, you need a balance sheet with assets opposing liabilities, etc. We don't have a balance sheet for the US, so we have to guess the effects of cash flows. Real per capita GDP is the best proxy we have and it has grown enormously during 50 years of bad trade deficits. That should tell you something.
Published: January 24, 2007 2:47 PM
"Thank you for at least acknowledging that there were trade deficits even when the US was on a hard money standard"
I'll accept your word for it, because I acknowledge the possibility, and I've never known you to lie. Make mistaken arguments, sure, but never lie :) Although I'm going to stop before accepting that there were persistent (not interrupted by any surpluses), constantly increasing trade deficits over long periods. That, to my understanding, can't be sustained in hard currency regimes - eventually you run out of currency to trade with absent the discovery of more raw material for the currency (did any of that happen in NA in the time we're discussing?)
The point about property rights violations deals with the fact that the thief will generally sell at a discount - think about the "entrepreneur" who sells top flight electronics out of the back of a truck. His costs are lower, so he can afford to under bid other sellers. Large scale theft can be especially profitable in this manner, as, for example, stolen land can be sold very cheaply as long as you maintain your own (well, that's more than just an example, it's a very important one for describing the time period we're talking about). By such methods, small numbers of people (the thieves) end up with more currency, even though the net result is less for the population as a whole. However, even this scenario can't continue forever without everyone in the deficit area eventually losing all currency under hard money. Eventually, the people in the region either balance their accounts, even if at a very low gross level, or they drop out of international trade and become a subsistence economy. You can't continue spending more gold than you receive indefinitely, absent theft or discovery of unowned ore.
Published: January 24, 2007 2:48 PM
RPM -
The problem doesn't always manifest itself in the same symptoms, especially when the internal processes are different. The symptoms of theft by monetary inflation are often different from the symptoms of theft by direct application. Also important are external circumstances. The relative rate of industrialization, the subjective wants of the thieves involved, etc. all will have an effect on what the symptom will be.
RogerM,
"OK, so you'll have to tell me which ones are insane and which ones aren't because I can't tell."
Shew, ever thought about trying out for the Wizard of Oz? I never said that I knew who might act irrationally, or that they will. I just posited that they might - you can't eliminate that possibility outright.
"Afterwards, foreigners decide to buy some American goods and invest some dollars in the US."
Certainly not true if one looks at the current accounts for foreign central banks. If they actually spent the money they're holding, you could expect to see massive price inflation that even the rigged CPI couldn't obscure.
"Such borrowing, and investment, increases production, wealth and consumption in the future."
Only if you have the magic perfect entrepreneur machine. Some such borrowing may in fact do that. And in fact, absent fiat money inflation, the reality is that most such borrowing does in fact do exactly that. But the reality painted by ABCT demonstrates that in the face of fiat inflation, ever increasing numbers of such borrowers make bad decisions, "clusters of errors" that are malinvested and do not yield future wealth.
Published: January 24, 2007 3:00 PM
quasibill: "Certainly not true if one looks at the current accounts for foreign central banks."
What central banks hold is a very small portion of the total dollars sent overseas over the last few decades. Increasingly, they're holding dollar-denominated assets (US stocks and bonds) instead of cash, and those dollars reduce interest rates in the US, which spurs investment.
Published: January 24, 2007 3:24 PM
RogerM:
Well, Roger here is where I suppose we're going to agree. I'm sure you meant to say "real per capita GNP is the best proxy [for living standards]" not "real per capita GDP". GNP subtracts from GDP a couple of things, the main one for the U.S. being net interest and dividends remitted to foreigners on the net U.S. international debt. These net interest and dividend payments, naturally, are not American income (and again, regardless who's doing the adding up of American incomes).
However, one more time! The main issue with RPM's article is that his saying that net foreign liabilities don't matter since they are simply the result of market transactions that either benefit all those affected by the transactions or are at the worst benign. This statement (once more) is patently false. Net foreign liabilities matter because as you argued above, they influence future generations' incomes.
Published: January 24, 2007 3:28 PM
quasibill: Eventually, the people in the region either balance their accounts, even if at a very low gross level, or they drop out of international trade and become a subsistence economy. You can't continue spending more gold than you receive indefinitely, absent theft or discovery of unowned ore.
OK, I realize all of us have been growing testy, but please listen to what I am saying.
You guys are thinking about this the wrong way.
The way the "trade deficit" is currently defined, suppose people in an-cap country A buy a bunch of books from an-cap country B for 1000 oz. of gold. During the same period, the people in country B buy 1000 oz. worth of stock shares in companies in country A.
The net gold transfer is zero. And if there are no other transactions, country A is runs a 1000 oz. trade deficit vis-a-vis B. So as this example shows, you could run a trade deficit without reducing the amount of gold in your country.
Now the question is, can the people in one an-cap region continually sell stock or bonds or other claims on future income flows, on net, to another region? Yes, they could. In our example above, if the people used the books to train themselves to become more productive, then the total market value of the companies in the region might go up by more than 1000 oz. of gold in the period. So the books "paid for themselves."
Especially if country A has a bunch of intelligent but ignorant workers, they could do this year after year, buying more and more books from region B, with a constant stream of trade deficits.
Again, I'm not saying this is necessarily what's going on with the current US. But you guys need to understand what "the trade deficit" *means* before you can decide if it's bad. We already know that central banking and fiat money are bad.
Published: January 24, 2007 3:57 PM
RPM,
"Official" trade deficits don't mean any more to me than the "official" inflation rate, and as mercantilism was the order of the day back then, it is to be distinguished from a true gold standard. Thus could one say, I suppose, that there were trade deficits of some kind, but more to the point:
"You're right, the overall trade accounts _do_ balance, but that's because a current account deficit can be offset by a capital account surplus. With two 100% an-cap regions, if the people in A are net investors vis-a-vis the people in B, then there would be a trade deficit between the two groups."
Assuming by "investors" you mean those who spend their money to purchase foreign goods, then if the money is sound (e.g., gold), calling the result a "trade deficit" is meaningless, since (we agree that) the goods traded for balance out. Rather, a line has been artificially drawn around a particular group of people (country A), who happen to have swapped more money (gold) for other goods (shovels) than a similar group elsewhere (country B). Hence, no "trade deficit." And as long as country A is able to produce enough wealth via savings-based production -- i.e., through work -- its citizens will be able to continue to purchase goods from country B, thus engaging in mutually beneficial trade that accordingly creates no deficit.
This isn't so in today's fiat-based world, however, where countries don't trade with sound money. For not only do these countries have their own currencies; they have currencies that, by government edict, are "legal tender" that is not a redeemable money substitute but money itself. As such, it is a financial instrument that ipso facto creates a "deficit" for the simple reason that no work (to speak of) is involved in its creation. Thus is the purchasing power of this "work-free" money reduced the more of it is created (simple supply and demand), and thus is inflation the inevitable result.
Moreover, to export this inflation via trade with a low-wage country is to export the deficit that work-free money creates. And however wrongheaded it is to dismiss the domestic deficit (the "national debt") as "owing it to ourselves," it is even more wrongheaded to say that exporting the deficit to another country doesn't matter. It DOES matter, and it matters in direct proportion to how large it is, ours being so monstrous that it represents an IMbalance the likes of which the world has never seen and that is accordingly unsustainable.
Thus did I take issue, and still do, with your "deficits don't matter" position, defending Schiff accordingly.
Published: January 24, 2007 3:57 PM
David,
In the same post you just told me that "'Official' trade deficits don't mean any more to me than the 'official' inflation rate..." and "Thus did I take issue, and still do, with your 'deficits don't matter' position..."
Do you see the irony of this? The huge, allegedly unsustainable numbers are the "official trade deficit" statistics, which I say are very misleading. Then you tell me those stats are useless, and that I am wrong for denying their relevance.
Once again, I agree central banks and fiat money are bad.
Published: January 24, 2007 4:05 PM
Dr. Murphy,
I see the irony.
Published: January 24, 2007 4:49 PM
RPM,
You maintain that there were trade deficits prior to our going off the gold standard, and all I said is that insofar as a true gold standard didn't actually exist, there could have been trade deficits to the extent that mercantilism had distorted free-market mechanisms (however paltry that distortion would have been relative to what we confront today).
In any case, the market tracks the bond trade -- i.e., the purchase of the debt without which our economy would collapse -- so saying that I don't buy into the "official" numbers simply doesn't wash.
More to the point, however, is that you had NO RESPONSE to the essence of my reply, which is (1) that fiat money causes relentless inflation, the exportation of which exports the deficit that is the essence of fiat money's work-free nature and (2) that this deficit matters precisely because it is a Ponzi scheme that is accordingly unsustainable.
So while you may "agree that central banks and fiat money are bad," you do the cause of freedom a disservice by defending the deficits-don't-matter position, as it defends the status (as in statist) quo.
Published: January 24, 2007 5:17 PM
David: "fiat money causes relentless inflation,"
No disagreement there.
"...the exportation of which exports the deficit"
I'm not clear what you're saying with the second part. Are you saying that the fiat money causes trade deficits, or that because of trade deficits exist, we're able to export our inflation? Also, I'm not clear what you mean by deficit in the sentence above.
"this deficit matters precisely because it is a Ponzi scheme"
Surely you don't mean all of the trade deficit is a result of fiat money. Murphy has tried valiantly to show that trade deficits would naturally occur, and have occurred under a pure gold standard. And he has about 200 years of economic theory to back him up. They occur because of what Ricardo called comparative advantage and they're nothing more than the spread of the division of labor. I'm afraid he's beating his head against a brick wall, though.
I certainly agree that some of the deficit is caused by fiat money, but probably a small part. A problem with fiat money is that it can do a lot of the same things as gold/silver, so in a lot of ways it works like real money; it just has some very bad side effects.
Under a gold standard, as Murphy, adi, Pepe, Smith, Ricardo and others have pointed out, a country whose economy is growing faster than other economies will run a high, persistent trade deficit as it borrows money from other countries to invest in new and expanded production. Such borrowing will cause that country to be richer in the future, and probably richer than those from whom it borrows.
Published: January 25, 2007 8:43 AM
RogerM:
Why do you and some others keep saying that trade deficits occur because of comparative advantage? The trading of exports for imports occurs due to comparative advantage. Trade deficits can only occur 1.) if the population of a country as a whole wants to spend more than its income and 2.) if international borrowing is possible to allow domestic spending to exceed domestic income.
Yes, it is true that investment financed by foreign debt increases a country's future wealth and income, if the rate of return exceeds the cost of foreign borrowing. (And that would be true for most rational investment.)
But what does all that have to do with the main thrust of RPM's article. The main theme was summed up by his statement: "It is true that a net inflow of capital represents growing liabilities to foreigners. But is this necessarily bad? After all, THERE SHOULD BE A PRESUMPTION OF BENIGNITY TO EACH INDIVIDUAL TRANSACTION, SINCE IT IS VOLUNTARY."
This part that I capitalized is the crux of RPM's view of net foreign debt. Most market transactions have the quality that they are welfare increasing, but not all have this quality. Sometimes, the expected benefits of a transaction are not realized. And not all parties affected by every market transaction voluntarily choose to transact. This means that it is perfectly valid to question transactions (including those that lead to net foreign debt) as to whether the result is benign, good,or bad.
Hence, it is perfectly valid to question the level of U.S. net foreign debt resulting from capital inflows (trade deficits). I think most people would argue that many of the transactions (especially the investment ones) that contributed to the net foreign debt were good, and many of the transactions that have led to the present U.S. net foreign debt (especially some of the government budgetary decisions chosen to be financed by borrowing) were bad. This implies that a portion (not all, of course, but a portion) of the present foreign liability of the U.S. has resulted from transactions that were anything but benign to the present and future generation.
Published: January 25, 2007 9:32 AM
Alex: "This implies that a portion (not all, of course, but a portion) of the present foreign liability of the U.S. has resulted from transactions that were anything but benign to the present and future generation."
I agree whole heartedly that some of the foreing debt is bad for the nation--the part that results from the federal deficit. But the problem is not the foreign indebtedness, it's the federal deficit.
"Why do you and some others keep saying that trade deficits occur because of comparative advantage?"
Because comparative advantage causes trade, but it doesn't guarantee balanced trade. Three things can cause the trade to be unbalanced:
1) Consumers in country A can't produce a product, or can't produce it as cheaply, as country B. Oil is a good example. Now if country B doesn't want anything country A has to export, a trade deficit follows.
2) Savings in country A are too small for the projects that businessmen in A want to start, so businessmen borrow from the savings in country B.
3) Businessmen in country B see more opportunities to invest in country A than in their country B.
All of the above are covered under comparative advantage.
Published: January 25, 2007 10:02 AM
RPM and RogerM,
I have rarely seen more disingenuous posts. Suffice it to say, you've had your clocks cleaned.
Published: January 25, 2007 10:21 AM
Yes, I think I'll rest my case at this point. I really enjoy the discussions at this site, however.
Published: January 25, 2007 10:38 AM
Reactionary: "I have rarely seen more disingenuous posts."
If you'll point out where we were disingenuous, I'd like the opportunity to defend us.
Alex: "I really enjoy the discussions at this site, however."
So do I. Your sharp observations really force me to think through the arguments carefully.
Published: January 25, 2007 10:58 AM
RogerM,
You and Robert have ignored the point raised from the very beginning: the capital account surplus cannot progress to infinity. At some point, your grocer is going to stop accepting little pieces of paper from you in exchange for his groceries. That's what a good part of the capital account surplus is: fiat currency and bank-created credit, NOT credit created from prior savings. This is why you and Robert keep erecting the straw man of trade deficits and comparative advantage, which nobody is arguing against.
Again, basic Mises: "Imports are in fact paid for by exports and not by money." Theory of Money and Credit @ p. 286.
Published: January 25, 2007 11:40 AM
RPM,
Per your last post, we are clearly talking past each other. I agree that you can't just point to a trade deficit and say "bad". But at the same time, you can't point to our current deficit in context and say anything other than "really bad". The context clearly matters, and a trade deficit tells you nothing more than what an accountant thinks of the exchanges that occur in the marketplace.
But if you look at the trade deficit in context, understand that it is persistent and increasing over a long period of time, and attempt to trace back the mechanism that is at the root, you CAN identify such long term, persistent, increasing trade deficits as the symptom of an economic illness.
Interesting example you use, but it doesn't seem to be all that possible in the real world - who's going to invest that much consistently over time in someone(s) who don't produce anything capable of generating a profit? You're making the same mistake RogerM continuously makes - investment is not some magical process that automatically results in wealth. Rather, it is at best an educated guess made by an expert in the field of predicting people's wants, and at worse (in the presence of unrecognized fiat inflation) a bet placed on zero on the roulette wheel. Wealth results from investment ONLY after someone uses the investment to produce something someone wants at cost they're willing to pay.
If you and RogerM continue to think that investment always produces wealth, I'd like to interest you in the Quasibill Wealth Creation (TM) fund. We invest your money - don't ask how, 'cuz it doesn't matter how - and we all get wealthy!
"they're holding dollar-denominated assets (US stocks and bonds) instead of cash"
What are U.S. bonds? A promise by the U.S. government to pay you a sum certain of U.S. $ at a certain date, backed by the full faith and credit of the U.S. government? Hmmm. Yes, I see the difference between that and that sum certain in $ on that date (or that sum certain minus a discount relative to inflation at this early date).
Published: January 25, 2007 12:27 PM
Reactionary: "You and Robert have ignored the point raised from the very beginning: the capital account surplus cannot progress to infinity."
You obviously don't know the meanings of "disingenuous" or "straw man" so I'll ignore those insults.
No one has ever claimed that the capital account surplus could progress to infinity.
"At some point, your grocer is going to stop accepting little pieces of paper from you in exchange for his groceries."
I completely agree that hyperinflation will cause people to quit accepting dollars. When will the grocer stop accepting them? When hyperinflation exists, which doesn't now exist and will not for the near future, at least.
"That's what a good part of the capital account surplus is: fiat currency and bank-created credit, NOT credit created from prior savings."
I've already agreed that fiat currency and bank-created credit aggrevate the situation. You say it's a good part, but how much is that? 30%? 90% My guess is that it's close to the rate of inflation, about 4%.
I'm not defending fiat money or bank-created credit. I'm as against them as you are. But I think they play a minor role in international trade.
In think this was Stephan's point above when he wrote "However, as I pointed out in my article on the subject, to the extent that it is caused by budget deficit or monetary driven asset price bubbles, it is a bad thing, as it will then go to finance consumption and malinvestments."
I agree completely. But those are small components of our international trade.
Stephan also discussed the issue of what would happen if the Fed stopped increasing the money supply, and concluded that the trade deficit would shrink. I agree. But it wouldn't eliminate the trade deficit. Comparative advantage causes trade deficits, not monetary manipulation. Monetary manipulation can aggrevate the situation.
But if the Fed quit expanding the money supply, why would the trade deficit shrink? Simply because the American people have less money to spend. Plus, higher interest rates would encourage some increased savings, which would lessen the need for borrowing abroad. However, after prices had adjusted to the lower level of money, the trade deficit would resume normal levels to reflect comparative advantage.
Published: January 25, 2007 12:46 PM
Reactionary,
Can you find that Mises quote in the online version?
http://www.mises.org/books/Theory_Money_Credit/Contents.aspx
BTW I'm not accusing you of disingenuousness, but I can't find the quote and I want to see the context.
Thanks.
Published: January 25, 2007 12:51 PM
Amusing paper.
It surely shows a righteous "harmless current account deficit" point of view (when transactions are free, the outcome is widely desired by agents, so a sustainability concern has got no reasons to arise).
Mr Murphy, let me ask you: would your opinion be the same, in case a foreing Central Banker decided to massively buy your bonds and liabilities (creating your capital account surplus) thus forcing exchange rate upwards so to make you internationally non-competitive (creating your current account deficit)?
Mr Murphy, let me ask more: is actual USA situation somewhere inbetween these two extreems (free trade & foreing Centrale Bank bias) instead of purely "free"?
Mr Murphy, please, one more question: do not you think a "sudden stop" in foreing Central Bank policy would involve some serious problems thus arising a "sustainability concern"?
Respect
LB
Published: January 25, 2007 1:08 PM
O.K., maybe just 1 more post.
I happen to have the following U.S. numbers handy for 2004: Net domestic investment=$893 billion; Household saving=$106 bill; Business saving=$478 bill.; Government saving= -$349 bill; current account balance = -$658 bill. New net foreign borrowing was therefore $658 billion.
Now, is there anyone who will claim that all the $658 was used to finance new domestic investment spending, and that none of it, for example, was used to finance the government spending-income gap of $349 billion, and that therefore none of the $658 billion increase in net foreign debt will lower incomes of future populations in spite of it increasing their debt service to foreigners?
Published: January 25, 2007 1:58 PM
Alex: "Now, is there anyone who will claim that all the $658 was used to finance new domestic investment spending, and that none of it, for example, was used to finance the government spending-income gap of $349 billion, and that therefore none of the $658 billion increase in net foreign debt will lower incomes of future populations in spite of it increasing their debt service to foreigners?"
I think Murphy and I agreed that the federal deficit will lower future incomes. But that's true whether we borrow from Americans or from foreigners.
Published: January 25, 2007 2:27 PM
RPM,
ch. 14, pt. 4. He also says it in what appears to be a precursor essay, "Stabilization of the Monetary Unit."
Robert Blumen says the same thing in his review of The Dollar Crisis.
"Where trade occurs between nations, imports must ultimately be paid for with exports. This is a special case of the general principle that consumption must be funded by production."
It also apparently appears in Mises' essay "Etatism, Protectionism and the Demand for Lebensraum."
"The ultimate goal of its foreign trade policy is economic self-sufficiency. The avowed tendency of this policy is, of course, only to reduce imports as far as possible; but as exports have no purpose but to pay for imports, they drop concomitantly."
Again, basic stuff, and disingenuous of you not to acknowledge that fiat money has created a substantial capital account surplus unsupported by prior production and, therefore, creating numerous distortions and malinvestment. Nobody is arguing against free trade, but that is how you are casting your opponents' positions.
Published: January 25, 2007 2:49 PM
well,
am I the last one?
well, if you read your mises carefully youl notice taht the problem with money creation is not inflation or trade deficits, etc. by them selfs .
the real problem with money creation is a "CALCULATION PROBLEM".
in a fiat money environment where money is created out of the blue and governments sponsor reckless credit creation there will come a time when citizens will not know what to do with their money(or will do the wrong thing with it as they are not able to "calculate") , malinvestments will occur galore, and nominal savings will go out of wack with real savings.
this will eventually become big trouble for everybody that will manifiest itself not in trade deficits or inflation but in in a whole lot of unfinished projects that mean real "wealth destruction".
if you add to this the government compulsion to intervene in times of troubles, well , then you have a "great depression".
olmedo
Published: January 25, 2007 3:20 PM
RogerM:
I agree with you (as anyone would) that a good portion of the present U.S. foreign liability has been the result of U.S. government spending in excess of its tax income. And, clearly you believe that this particular portion of the U.S. foreign liability has resulted from bad U.S. government decisions, not voluntary decisions that benefitted everyone concerned. But, that position violates RPM's main premise that I've been harping about.
Published: January 25, 2007 5:42 PM
"If the Fed credibly promised never to print another dollar bill, there would be tons of net foreign investments in U.S. assets,i.e current account deficit would go way up".
Oh really? And just what assets would they invest in? Bonds? Well, sure, bonds with nominal bond yields would rally big time. But there is no reason at all to expect real bond yields to decline. While there is good reason to think nominal yields would fall in the case of the destruction of the Fed (given the elimination of the inflation premium), there is no reason to assume real yields would fall. Indeed there is good reasons to expect them to rise, given, you know the law of demand, which I assume you (RPM) have heard of. The Fed creates money (as you may have heard) by buying government securities using the money they themselves created "out of thin air". Lower demand (given the elimination of the Fed) will lower its price, or in other words raise their yields.
What about real assets (stocks, real estate etc.) then? Just why would foreign demand for that increase in the demand of the elimination of the Fed? As real assets do not lose real value in the case of inflation, but instead are more or less automatically increased in nominal terms, there is no reason at all to expect foreign net investment to increase. Indeed, as monetary inflation tend to disproportionately affect asset prices (aka prices of investment goods), there is every reason to think that the elimination of the institution which has artificially boosted asset prices, will lower their attractiveness.
Published: January 25, 2007 6:18 PM
Stefan:
Before trying to parse each step in your argument, I want to make sure I understand you. Right now there is a certain amount of foreign capital flowing into US assets. That is, foreigners decide to invest a certain amount in US assets, and Americans decide to invest a certain amount in foreign assets, and right now the foreigners want to put on net more into the US.
Now imagine Ron Paul somehow puts a magic spell on his peers and gets them to abolish the Fed and go back on a gold standard. You're saying this would alter everyone's decisions, and people would rush to move their capital out of this country?
Or we could try it the other way: If a Latin American country announces that it will start running the printing press at 100% per month, do investors flock to assets of that country?
Please realize that you can concede this point without thereby endorsing central banking. In fact, I would think this point would reinforce how bad it is: When you establish a central bank, you scare away investors who otherwise would've put real capital goods into your country.
But you're saying I have this backwards?
Published: January 25, 2007 8:24 PM
RPM, what you are missing is first of all the distinction between the 3 different forms of inflating, which I spelled out in my initial reply. The distinction between what one might call foreign exchange reserve accumulation, general price inflation and Austrian Business Cycle Theory(ABCT)-booms. Foreign exchange reserve accumulation is likely to lower the trade deficit/increase the trade surplus (depending on what the initial balance was), general price inflation is not likely to affect the trade deficit. There are however good reasons to expect a ABCT boom to expand the trade deficit.
When the Fed lowers interest rates, it will set into motion a investment boom. But this higher investment rate won't imply lower consumption. Quite to the contrary. Rate cuts will raise stock and real estate prices which through the so-called wealth effect will -together with the lower interest rates- lower savings and increase consumption. But the only way that both investments and consumption can increase is through a increased trade deficit (or lower trade surplus).
While part of that trade deficit increasing effect will be cancelled out by the weaker currency implied by lower interest rates, it will only be part of it because 1) By lowering the current exchange rate more than the expected future exchange rate, it will make dollar denominated assets attractive despite lower yields 2) The inflationary boom by raising corporate profitability will make U.S. stocks more attractive 3) Asian central banks and oil exporting governments will then invest even more in dollar assets to ensure their currencies that don't get so strong that their export companies get badly hurt.
These three reasons also spell out from why a monetary driven ABCT-cycle would attract the capital inflow needed to finance the trade deficit.
Published: January 26, 2007 4:05 AM
Stefan,
OK again, I want to make sure I understand your position. From your last response I take it that you agree with me, that if a Latin American country said it would start running the printing press like mad, that nobody in his right mind would invest there, and in fact everyone would try to relocate their assets out of that country. I.e. there would be a huge capital deficit / trade surplus in that country after the announcement.
So is it just a matter of degree? I.e. are you saying that if the Fed habitually added 50% to the money stock per year, and then it were abolished by Ron Paul, that _that_ would increase the trade deficit (as I've maintained all along)...
BUT, since right now the Fed isn't so much as overall inflationary, but rather messes up relative sectors (stages in Mengerian terms), that this tendency of the Latin American country example is offset by the ABCT considerations?
Again, to sum up: I thought I made it pretty obvious in my last post that if you push it far enough, clearly an irresponsible central bank can cause world investors to steer clear of assets denominated in the currency that's about to be devalued. You didn't deny that, and instead made several distinctions among types of inflation.
So by that, I took it you agreed with my Latin American case.
Thus, the reason you deny my current claim--namely that if the Fed stopped printing new money, trade deficit would go up--is that you believe the Fed right now is being fairly responsible, and so isn't scaring off investors in a hyperinflation-type scenario. In fact, you maintain it's just the opposite, that perversely the Fed's tinkerings have made the US a relatively attractive haven for foreign investors, more attractive than if the US were on a gold standard.
Is this right?
Published: January 26, 2007 6:23 AM
"Where trade occurs between nations, imports must ultimately be paid for with exports. This is a special case of the general principle that consumption must be funded by production."
RPM won't call you disingenuous, but I will, especially since you seem stuck on the term. You took that quote out of context, which is a clearly a dishonest move. Mises isn't talking about trade deficits in that passage. He's talking about exchange rates and irrational fears on the part of mercantilists. Here's the lead sentence for the section:
"According to the current view, the maintenance of sound monetary conditions is only possible with a "credit balance of payments."
To take that sentence out of context and try to make it Mises's views on trade is simply dishonest. It suggests that Mises thought that trade in products and services should always balance.
Here's a better passage:
"It is customary to list separately the monetary and the nonmonetary items of a country's balance of payments. One calls the balance [p. 452] favorable if there is a surplus of the imports of money and bullion over the exports of money and bullion. One calls the balance unfavorable if the exports of money and bullion exceed the imports. This terminology stems from inveterate Mercantilist errors unfortunately still surviving in spite of the devastating criticism of the economists. The imports and exports of money and bullion are viewed as the unintentional outcome of the configuration of the nonmonetary items of the balance of payments. This opinion is utterly fallacious. An excess in the exports of money and bullion is not the product of an unhappy concatenation of circumstances that befalls a nation like an act of God. It is the result of the fact that the residents of the country concerned are intent upon reducing the amount of money held and upon buying goods instead. This is why the balance of payments of the gold-producing countries is as a rule "unfavorable"; this is why the balance of payments of a country substituting fiduciary media for a part of its money stock is "unfavorable" as long as this process goes on." Human Action, http://www.mises.org/humanaction/chap17sec14.asp
It's clear from this passage, and others, that Mises considered trade surpluses and trade deficits to be benign and that trade deficits could exist indefinately.
A little bit of history should make this perfectly clear: Japan and Germany have run trade surpluses with us for almost 50 years. Which of the three countries do you think is richer?
Alex: "But, that position violates RPM's main premise that I've been harping about."
Are you referring to his contention that we should view trade deficits as benign? RPM can defend himself, but I would argue that the Federal deficit is the problem, not the trade deficit. It's entirely possible that without the Federal deficit, foreigners would purchase private bonds instead of government ones and the trade deficit might remain the same. It's hard to tell, though.
Published: January 26, 2007 8:53 AM
Here's another interesting passage from Mises:
"The maintenance of a sound currency has nothing to do with foreign trade. It is the old and fundamental error of all types of Mercantilism, that an unfavorable balance of trade drives money out of the country. But the balance of trade is one item only in the balance of payments. An excess of imports over exports is compensated or over-compensated by assets from other items. The balance of payments always balances. If both sides of the balance of payments equalize only by an export of gold, prices have to fall. The low prices increase exports and check imports. In countries where the currency is not purely metallic, the outflow of gold forces the Bank to restrict credit. Then the adjustment is effected by the inflow of foreign short-term loans attracted by the higher rate of interest. Thus, under both conditions, the equilibrium is re-established automatically." Money Method and the Market Process http://www.mises.org/mmmp/mmmp9.asp
Clearly, in this passage Mises indicates that balancing the exchange of goods with money transfers is the normal working process. But that requires a trade deficit and capital surplus, something Mises doesn't find objectionable.
Also, Mises writes "The theory of foreign trade as stated by Ricardo has proved in an irrefutable way that free trade only ensures the highest productivity of the economic efforts and that every kind of protectionism must necessarily result in a reduction of the output of capital and labor." Mises was clearly a fan of Ricardo, who would never have insisted that trade in goods and services must balance.
Published: January 26, 2007 9:06 AM
"...if the Fed stopped printing new money, trade deficit would go up"
WRONG!!!, most likely interest rates will go up severely ( remember Paul Volker?), credit will collapse, and consumers and investors in todays "malinvestments" will go busted. Therefore, consumption will be much lower and with it, fixing the trade deficit.(no more Plasma tv´s any more!)
as assets prices will certainly go lower in the US , produced by the liquidation of malinvestments, export opportunities will arise however, this will not be that easy as it is not easy to transform a Walmart into an export oriented factory. It is much easier to hold consumption than to increase production.
i think this is a likely scenario (it already happened in the late 70s) if the possibility of a "run on the dollar" becomes evident to the fed . and I, personally believe, that this a likely scenario in the near future.
"""if a Latin American country said it would start running the printing press like mad, that nobody in his right mind would invest there, and in fact everyone would try to relocate their assets out of that country. I.e. there would be a huge capital deficit / trade surplus in that country after the announcement.""""
YES and NO. Remember, people don't invest in countries, people(ultimately) invest in assets, real assets. And assets are different and differently affected by inflation and Latin American countries do have real assets outside their crappy currencies.
I still remember going to Argentina as a tourist after the 2001 peso crisis, the only problem was booking flight, the country was flooded with tourist why, because buenos aires, one of the most wonderful cities in the world, went from being one of the most expensive cities to one of the cheapest. The tourist industry went from a bust , in the 90s, to an spectacular boom in 2001. The same happened in other competitive Argentinian industries like agriculture and wine making. However, the Argentinian consumer, who made a living in pesos, was "busted"..Poor guys!!!
Published: January 26, 2007 9:08 AM
RogerM:
In your Mises quote, "...imports must ultimately be paid for by exports..." the word "ultimately" does not imply that he said the trade balance must always be zero, with exports always equal to imports.
With regard to your question concerning what was RPM's main premise of his article that I've been harping about, for the umpteenth time it is the RPM statement that I have capitalized in the following: "It is true that a net inflow of capital represents growing liabilities to foreigners. But is this necessarily bad? AFTER ALL, THERE SHOULD BE A PRESUMPTION OF BENIGNITY TO EACH INDIVIDUAL TRANSACTION, SINCE IT IS VOLUNTARY." As I said in my last post to you, by your previous post, to which I was replying (about all that debt financed government spending partially contributing to these foreign liabilities), you must also agree that the capitalized remark is wrong. Right?
Published: January 26, 2007 9:28 AM
RogerM, your obviously don't know what Mises is saying, as he's talking about trade in a sound-money -- i.e., gold standard -- economy in which "The confrontation of the money equivalent of all incomings and outgoings of an individual or a group of individuals during any particular period of time is called the balance of payments. The credit side and the debit side are always equal. The balance is always in balance."
Artificial political boundaries don't change this fact -- i.e., they don't create "favorable" and "unfavorable" surpluses but are simply "the result of the fact that the residents of the country concerned are intent upon reducing the amount of money held and upon buying goods instead." That's why "the balance of payments always balances" and why it is definitely NOT the case that this "requires a trade deficit and capital surplus." Sound money IS capital, and it has simply been traded for other capital goods as a result of resident individuals' varying intentions.
Where a trade deficit DOES come into play is in a fiat-based economy, such that its work-free nature creates a deficit that can only be "repaid" through the expansion of that deficit, no matter that it be domestic (the "We owe it to ourselves" fallacy) or foreign.
In both cases, real deficits are created, the only difference in the present case being that as the world's reserve currency, the "dollar" (i.e., the irredeemable Federal Reserve Note) all but requires foreign central banks to hold them in order to keep the value of their own currencies down so as to prop up exports.
The net of effect of these foreign bank holdings of the dollar via the purchase of US government bonds is to create vastly more debt than would otherwise have been created.
And bona fide Austrian that he is, this is precisely what Peter Schiff is arguing, why Robert Murphy is accordingly wrong, and why it is an outrage that such an anti-Austrian piece found its way into this forum. For the plain fact is that deficits DO matter and that our deficit has risen to the point that our economy teeters on the brink, only awaiting "diversification" out of the dollar, as it endlessly depreciates, for this Mother of All Ponzis to collapse.
Published: January 26, 2007 9:39 AM
Here's how exports pay for trade deficits, even when there are continuing trade deficits and thus, year after year, an increasing U.S. foreign liability.
Suppose the foreign liability is $400. Suppose the annual debt service on that liability is 8%. The 8%x$400=$32 of U.S. funds that is received by foreigners in the year purchases $32 worth of U.S. exports. If the U.S. runs no more trade deficits, but simply maintains the foreign liability at $400 indefinitely, the present value of U.S. exports bought by foreigners with their $32 per year U.S. debt service receipts is $32/8%=$400.
The previous result is independent of whether the U.S. does run further deficits and increases foreign liabilities. For example, suppose there is a trade deficit (capital surplus) in a given year of $32. That is to say, the U.S. borrows from foreigners the $32 required to service their existing foreign debt. Does this mean the U.S. has escaped the pain of having to export some of its goods and services to service its $400 liability? Absolutely not. The $32 additional foreign debt must be serviced each year (say, also at 8%) by an additional 8%x$32=$2.56 of payments to foreigners, which are claims on U.S. exports. The present value of the additional $2.56 debt service to foreigners each year is $2.56/8%=$32. Every dollar of foreign debt acquired requires exports to service the debt. And, the present value of these exports is exactly equal to the amount of the debt.(Another way to look at is that in the absence of foregin debt, the payments to foreigners to service the debt, instead could have been used to purchase foreign imports.) However you wish to view it, each dollar of foreign debt is paid back in the form of exports (or fewer imports), either way a cost to the U.S.
Published: January 26, 2007 10:36 AM
"In fact, you maintain it's just the opposite, that perversely the Fed's tinkerings have made the US a relatively attractive haven for foreign investors, more attractive than if the US were on a gold standard.
Is this right?"
Once again, jumping in, but I'd say you're ignoring the context again. Take this (I wish entirely hypothetical) example:
Country A uses fiat currency, and inflates its supply at just over 4% per annum over 5 years, say going from 5,000 billion dollars to 6,327 billion dollars in that time.
Country B, also on a fiat currency (a different one), increases its supply at some percentage, going from 5,000 billion to just north of 7,000 billion in the same time.
Where do you invest? Does that automatically make that country "better" than the gold standard?
Also, we can't forget that knowledge of Austrian economics isn't widespread among the investoriat. Just because we understand the nature of monetary inflation and its effects, doesn't meant the dumbed down masses or even the financial sophisticates (who are most often Keynesians) do. Much of what makes the U.S. attractive right now is based on irrationality spurred by historical happenstance, coupled with ignorance of what is actually the state of the money stock. This sort of irrationality can reverse itself with a vengence.
Published: January 26, 2007 10:54 AM
This pretty much says it all, especially as it comes from the mouth of a former central banker:
Speaking specifically about the US trade position, Fell said: “The U.S. annual trade deficit, now running at a rate of more than three-quarters of a trillion annually, or 6.3 percent of GDP, is a huge concern. It's not prudent for the U.S. to depend on foreign bond buyers to finance domestic consumption. Asian countries produce low-cost goods which are shipped to the United States, the U.S. ships dollars back to Asia, and then the Asians purchase U.S. treasuries. One could say this is a giant international Ponzi scheme. I don't think this model is viable or sustainable. Asian central banks will not want to accumulate U.S. dollars at the current rate forever. There is no free lunch. Virtuous circles like this, where everyone appears a winner, always come to an unhappy ending.”
http://www.mineweb.net/mining_finance/599990.htm
Published: January 26, 2007 11:26 AM
quasibill: Country A uses fiat currency, and inflates its supply at just over 4% per annum over 5 years, say going from 5,000 billion dollars to 6,327 billion dollars in that time.
Country B, also on a fiat currency (a different one), increases its supply at some percentage, going from 5,000 billion to just north of 7,000 billion in the same time.
Where do you invest? Does that automatically make that country "better" than the gold standard?
To remind you of the context (which you think I am ignoring), I said that if the Fed stopped printing money, net foreign investment in the US would go up. So you should change your hypoethetical to:
Country A: 4% inflation per annum.
Country B: Pure gold standard.
Which country do I invest in? B. I think most others would say the same. Without knowing more, I'd guess B would have a capital surplus, i.e. a current account deficit.
But Stefan disagrees, I think.
Published: January 26, 2007 12:48 PM
David White,
If I can find a quote from a central banker who sees nothing wrong with the current system, will you say that cancels out your quote? Or are central bankers only experts when they agree with your view?
Also, I think there are plenty of "virtuous circles where everyone is a winner" in economics.
Once again, I am against central banking. It would be better if the US were on gold. And here's where I differ from you guys, I say that improvement would manifest itself in more net inflow of capital, i.e. higher trade deficit.
Published: January 26, 2007 12:51 PM
RPM,
"I think there are plenty of 'virtuous circles where everyone is a winner" in economics.' "
I can think of one;i t's called a sound-money, free-market economy. (But no, the central bankers loose big time, as they all go out of business.)
But as we no doubt agree on that, let me set the record straight by saying that Fell's comments "say it all" not because he's a former central banker. Rather, they say it all regardless of who said them and only gain force because of their source.
As for the issue as a whole, the inflow of capital would be good in a sound-money, free-market economy, as it would balance with the outflow in what one would expect would be burgeoning international trade. Under the circumstances, however -- and there is no doubt in my mind that Mises would agree -- the massive and ongoing deficit must ultimately unwind, spelling doom for the US economy.
In fact, I have a standing bet with Arthur Laffer in the amount of one constitutional dollar -- i.e., "four hundred sixteen grains of standard silver": http://landru.i-link-2.net/monques/coinageact.html -- that the Federal Reserve Note won't see its 100th birthday seven years from now.
Published: January 26, 2007 1:15 PM
Alex: "AFTER ALL, THERE SHOULD BE A PRESUMPTION OF BENIGNITY TO EACH INDIVIDUAL TRANSACTION, SINCE IT IS VOLUNTARY." ...you must also agree that the capitalized remark is wrong. Right?"
For it to be wrong, you would have to show that invidual decisions to buy imports or invest in US assets are involuntary. I don't see how that could be. Who's forcing whom to do these things. I agree that the Federal deficit damages the future economy, and many foreigners and central banks are buying Federal bonds, but who's putting a gun to their heads?
David: "Sound money IS capital, and it has simply been traded for other capital goods as a result of resident individuals' varying intentions."
I've already agreed above that fiat money aggrevates the situation, but it's not the cause of trade deficits. It's a small part of the problem.
"the "dollar" (i.e., the irredeemable Federal Reserve Note) all but requires foreign central banks to hold them in order to keep the value of their own currencies down so as to prop up exports."
Not at all. Foreign banks have all kinds of options. They are not at the mercy of our inflation. They CHOOSE to buy up dollars from their people because of their flawed economics. They're mercantilists! No one and nothing forces them to do anything.
"The net of effect of these foreign bank holdings of the dollar via the purchase of US government bonds is to create vastly more debt than would otherwise have been created."
Not at all. Someone in the US has to demand the foreign money and supply the US bonds. The Federal debt was created by the US. Foreign purchasers have nothing to do with how much debt the Feds create.
Alex: "However you wish to view it, each dollar of foreign debt is paid back in the form of exports (or fewer imports), either way a cost to the U.S."
You're math examples are interesting, but they leave out so much and assume too much. The trade deficit could be paid for with new financial assets (stocks or bonds or direct investment), that is by creating new debt, from now to eternity without ever exporting a single good or service. But there's a caveat: we could do that only if our economy grows faster than the growth of the debt. However, that shouldn't be hard, for most businesses in the US finance their growth with huge amounts of debt, but the earnings from those investments easily service the debt with good profits left over.
David quoting central banker: "One could say this is a giant international Ponzi scheme. ...Virtuous circles like this, where everyone appears a winner, always come to an unhappy ending.”
So a central banker is a mercantilist! Most of them are. Re-read what Mises wrote about the fallacies of mercantilism, or Adam Smith.
RPM: "I say that improvement would manifest itself in more net inflow of capital, i.e. higher trade deficit."
Amen! A country with a pure gold standard would see its people getting richer than those in countries with fiat currencies and they would buy more imported goods. Also, businesses would grow faster without the the malinvestment caused by fiat currencies, so everyone in the world would want to invest in a gold-standard country, and that requires a trade deficit.
Published: January 26, 2007 1:48 PM
RPM:
Well, then I'll "up-context" you one more - what happens when Country B switches from its explosively inflationary monetary policy to the gold standard? What happens to the economy that was built in response to the easy money flow? To all the asset bubbles that grew in response to the easy liquidity? To all the debt used in its heavily leveraged hedge funds and private equity markets?
If the primary "growth" industry of a country is financial, what happens when the monetary spigots are shut off? What happens when the 1 in 4 new jobs generated in the last decade in finance suddenly come under deflationary pressures engendered by the shut off? What happens to the value of bubble assets when there isn't more liquidity available to sustain the massive speculative industry that has grown up?
Sure, long run, after the short run collapse, the gold standard country is going to be more attractive to foreign investment. Short run, when people come to realize the reality of the bubble market, and turn from business models based on excess liquidity to models based on actually producing something that someone else wants, and especially if psychology overtakes economics (markets can remain irrational for longer than most people can stay in them) - things could be quite different in the short run. Even more different if this massive dislocation in the short term leads to massive state intervention based on popular outcries.
Suddenly, despite returning to a gold standard, Country B can look like worse place than Country A, if Country A's assets haven't been subject to the same bubble economics.
Finally, even if Country A's assets ARE subject to an equivalent bubble, it is possible that after many years of outsourcing production in favor of financial bubble related industry in Country B, that Country A will survive the crash in much better shape than Country B - the infrastructure and capital base for actually producing things of value will be in better shape. While perhaps capital will see a higher return in Country B for a while due to this fact, the standard of living, etc., will likely be better in Country A for some time due to this fact.
One must never lose sight of the fact that investment doesn't create wealth, entrepreneurial production does. One can invest his life's savings in building a mock-up Klingon Battle Cruiser, but if it's not coupled with entrepreneurial production, it won't generate any wealth. Similarly, one can spend vast sums of money creating financial assets and markets to sell them in, but if it isn't paired with entrepreneurial production, it won't result in wealth. One of the problems with massive fiat inflation is that people tend to create major speculative markets that appear to generate wealth in response to the perceived surplus of savings. While running, these bubble markets will siphon capital from other, more actually valuable, markets, because the artificial returns are higher than anywhere else.
Does the term "artificially high return asset market" describe anything in the U.S. today? (note, to determine what a natural rate of return or P/E ratio on stocks is, you'd have to look at the market BEFORE the Fed came into being). Could not speculation based on such artificial returns play a major factor in the current balance of capital?
However, once the monetary spigot is turned off, these markets are revealed for the sham they are and collapse. Which is why it is wishful thinking to talk about them being turned off - there will never be sufficient political will to do so - hence Bernanke and his helicopters. What will happen is ever increasing liquidity to cover what's already wrong, with increasing police state crackdowns on those who dare question or flout government policy by, say, engaging in trade with gold.
What could be a useful measure is somehow classifying what is "good" capital inflow right now versus purely speculative bubble stuff.
Published: January 26, 2007 2:52 PM
In fact, I have a standing bet with Arthur Laffer in the amount of one constitutional dollar -- i.e., "four hundred sixteen grains of standard silver": http://landru.i-link-2.net/monques/coinageact.html -- that the Federal Reserve Note won't see its 100th birthday seven years from now.
This is intriguing. What do you mean, though? You challenged him on the Internet, or would he actually know you and is aware of the bet?
And you're saying the dollar won't be used seven years from now?
BTW I doubt very much that prediction, but I applaud you for actually making concrete statements. As I said in the article, anybody can predict recession (or some other calamity) if not held to a timetable.
Published: January 26, 2007 3:03 PM
RPM,
Yes, it's a challenge based on an ongoing Internet exchange, and yes, I'm saying that the dollar will be history by then, though not necessarily that we will have returned to a gold standard.
More likely, I think, is that the crisis in the Middle East will be used by Bush or his successor (though I think that Bush, being increasingly desperate, will engineer it) will declare a national emergency in order to ram the North American Union down the American people's throat -- http://www.humanevents.com/article.php?id=14965 -- doing so for two reasons: (1) to essentially naturalize the Mexican workforce in an attempt to stave off the collapse of our welfare system, and (2) to replace the collapsing dollar with the amero -- http://www.humanevents.com/article.php?id=15017.
Sounds absurd, I know, but I frankly think there is bipartisan support for the NAU, as both parties know that no serious action will be taken by Congress to heed Bernanke's warnings last week about the "severe" effects on the US economy "if government debt and deficits were actually to grow at the pace envisioned by the CBO's scenario." And however more absurd this may sound, it would not at all surprise me if Bush 39's new best buddy Bill Clinton were appointed to head the NAU's "governing body." (You don't think he could stand by and play second fiddle to the old ball and chain, do you?)
But in any case, I think we're at the tipping point and that any number of events could send the US economy over the top.
After all, trade deficits are unsustainable. : )
Published: January 26, 2007 3:42 PM
Yes, it's a challenge based on an ongoing Internet exchange...
I'm sorry to keep bothering you about this, but this really intrigues me. You're saying the Arthur Laffer of Curve fame has sent emails back and forth with you, and agreed to this wager? When did this happen and how did you contact him? Through CNBC or something?
Published: January 26, 2007 3:52 PM
Sorry, but that's between him and me.
My plan, in any case, is to collect over lunch and the Waldorf's Bull & Bear, then to land a speaking engagement at the next LRC conference. : )
Published: January 26, 2007 4:25 PM
David: "My plan, in any case, is to collect over lunch and the Waldorf's Bull & Bear, then to land a speaking engagement at the next LRC conference."
I hope you lose, but like RPM, I applaud your nerve as well as the salesmanship required to get Mr. Laffer into such a bet.
Published: January 26, 2007 5:00 PM
RogerM,
"I hope you lose..."
That's the real irony in being a contrarian (as I think any true Austrian/libertarian must be). That is, if you're standing on the deck of your beach house and see a tsunami coming, and yet can buy homeowners' insurance on the cheap -- and indeed as many policies as you like -- then that's the smart thing to do.
It's not that you WANT the tsunami to hit; it's that in seeing it coming (never mind that almost nobody else does), you place your bet (the Laffer one being but a side bet) and do whatever else is necessary to survive the catastrophe.
Maybe you won't-- i.e., maybe there's no avoiding the tsunami, no matter how far inland you get -- but you do what you can, determined to be guided not by wishful thinking but by critical thinking. And as the latter begins with questioning your assumption (something very few people do), you are fortunate to end up at forums like this one -- even when you end up in disagreements like the one that has been going on in this thread.
Yes, I believe that Robert Murphy is wrong on trade deficits, and yes, I am outraged that LvMI chose to publish his article. But at least we've had the opportunity here to debate it, allowing visitors to decide for themselves who is right.
And time will tell in any case.
Published: January 26, 2007 5:22 PM
Well, RPM, yes, I am indeed arguing that current Fed policy have induced net capital inflow ( aka increased current account deficit). But net capital inflow isn't necessarily a good thing ( another point which you seem to have missed). To make that point more obvious: in the end, aggregate economic statistics for countries are just the sum of the individual balances (and government balances) of the people living there. And so, what is true for individuals are also true for aggregates of individuals. Now imagine some liquor store salesman convincing some millionaire to use up all of his wealth to get really drunk -using the liquor store's products of course- every single day during a full year or so. That would in trade accounting terms amount to a massive capital inflow to the soon impoverished ex-millionare. Would that be positive for the soon to be impoverished ex-millionare?
Published: January 26, 2007 5:32 PM
Unfortunately, I don’t have time or patience to read a hundred and something responses to Dr. Murphy’s article. Instead, I will only reply to his original posting (response to Dr. Schiff). If I raise some points that were already addressed, please forgive me. The fact that the debate is still ongoing shows that objections were not effective enough (since Dr. Murphy is an open-minded intellectual who, unlike some contributors to this blog, seriously considers any objection that is raised against his arguments).
CURRENT ACCOUNT DEFICIT = CAPITAL ACCOUNT SURPLUS
Dr. Murphy states the following:
“…suppose that shovels are the only type of good in the world. In this (absurd yet instructive) scenario, a capital account surplus would mean that foreigners send more shovels into the United States than Americans send out; i.e., there would be a net immigration of shovels into the country in a given period of time.”
Following this hypothetical scenario, Dr. Murphy concludes that the US trade deficit of shovels is the flip-side of capital account surplus. However, by stating that the U.S. “purchased” shovels, he suggests that there was a monetary exchange involved in transfers of these shovels (in other words, shovels cannot be the only good in this example – there must exist some widely accepted commodity like gold). This means that the U.S. capital outflow (gold and shovels going to foreign countries) could theoretically be greater than the capital inflow (gold and shovels coming into the U.S.A.) if the price of shovels fell when the U.S. was selling them and went up when the U.S. purchased them from the world.
In the scenario with shovel-economy (for simplicity purposes, the planetary rate of interest is uniform and depreciation is miniscule), imagine that one U.S. shovel used to sell its shovels for 2$/unit (or an equivalent amount of gold), but the price went up when the U.S. imported shovels to the current level of 4$/unit. Also suppose that the U.S. purchased 50 E.U. shovels during a fiscal year, while the rest of the world purchased 20 U.S. shovels.
This means that the U.S. capital outflow amounts to: 200$ in. gold plus 80$ in current value of shipped U.S. shovels - for the total of negative $280.
At the same time, the U.S. capital inflow amounts to 40$ in gold (for sale of U.S. shovels) plus $200 in current value of imported E.U. shovels – for the total of $240.
Capital account balance of the U.S. amounts to a deficit of ($40).
Even without this hypothetical, it is not difficult to imagine a scenario in which a country may run both current account as well as capital account deficits. In 1990s FR Yugoslavia had a large current account deficit, largely due to the UN sanctions and unilateral transfers to Bosnian Serbs. At the same time, virtually no foreign investments took place, while people were fleeing the country, taking assets with them (capital outflow). Unlike Dr. Murphy’s (and Milton Friedman’s) scenario in which foreigners always bring us back those dollars that go out of our country (by purchasing American products like Fords or investing in our assets), no foreigners rushed to buy Yugos or to invest in a collapsed socialist economy.
ARE LIABILITIES ALWAYS BAD?
I agree with Dr. Murphy on this point – liabilities are not bad, as long as they are used for production. A country may even run small current account deficits, due to investments in new technologies, but the purpose of these investments is to produce revenues. If liabilities keep exceeding anyone’s liabilities year after year, something is probably wrong with that production. Note that I avoid using “trade deficits” as any useful parameter, simply because it cannot lead to any meaningful conclusion regarding a country’s economic performance. Trade balance sheet only records exchanges in goods, while any earnings on services (tourist sectors, etc.) do not count. Tourist paradises and tax havens are destined to have trade deficits, but no one would argue that they should do something about it by building heavy industries and forsaking its service sectors.
ARE THE TRADE DEFICITS UNSUSTAINABLE?
I also agree with Dr. Murphy on this point as well: trade deficits do not have to be unsustainable. Trade balance sheet only records exchanges of goods, while neglecting services and unilateral transfers. Current account deficits are not sustainable, because they are not synonymous with inflow of capital – but only with the outflow portion of capital account balance sheet. You cannot have a sustainable loss of financial assets over a long period of time.
USA: INVESTOR'S HAVEN?
Dr. Murphy looses his patience with Dr. Schiff and he states:
“Now we've finally hit the point where I've lost patience with Mr. Schiff. Does he really mean to say that these silly foreigners know less about their billions in investments than he does?”
Some lazy thinkers say that “cluster of entrepreneurial error” in Austrian business cycle also suffers from the same problem (we claim to know better than people who malinvest and loose their billions after an artificial boom goes into a bust). That is not a logically valid argument against Dr. Schiff. It is quite possible that the sense of relative security in the U.S. economy is based on boom during 1980s and 1990s, and GDP figures after 2000 that are mostly inaccurate and product of artificial credit creation.
Published: January 26, 2007 6:28 PM
RPM:
"...if the Fed stopped printing new money, trade deficit would go up"
WRONG!!!, most likely interest rates will go up severely ( remember Paul Volker?), credit will collapse, and consumers and investors in todays "malinvestments" will go busted. Therefore, consumption will be much lower and with it, fixing the trade deficit.(no Plasma tv´s anymore!)
as assets prices will certainly go lower in the US , produced by the liquidation of malinvestments, exports and new investments opportunities opportunities will arise; however, this will not be that easy as it is not easy to transform a Walmart into an export oriented factory. It is much easier to hold consumption down than to increase production.
i think this is a likely scenario (it already happened in the late 70s) if the possibility of a "run on the dollar" becomes evident to the fed . I personally believe that this a scenario is possible (and necessary) for the near future the alternative is, reneging debts with inflation(hyper?) and, as a consequence, the collapse of the middle class as in argentina.
"""if a Latin American country said it would start running the printing press like mad, that nobody in his right mind would invest there, and in fact everyone would try to relocate their assets out of that country. I.e. there would be a huge capital deficit / trade surplus in that country after the announcement.""""
YES and NO. Remember, people don't invest in countries, people(ultimately) invest in assets, real assets. And assets are different and differently affected by inflation and Latin American countries do have real assets outside their crappy currencies.
I still remember going to Argentina as a tourist after the 2001 peso crisis, the only problem was booking flight, the country was flooded with tourist why, because buenos aires, one of the most wonderful cities in the world, went from being one of the most expensive cities to one of the cheapest. The tourist industry went from a depresion , in the 90s, to an spectacular boom in 2001. The same happened in other competitive Argentinian industries like agriculture and wine making.Thus, foreign capital went to those. On the other side, the Argentinian consumer, who made a living in pesos, was "busted"..Poor guys!!!
Published: January 26, 2007 9:11 PM
Aw shucks, olmedo, I think you may have answered a question I was going to ask: would the fact that foreigners getting U.S. dollars as payment be incentive against hyperinflation of the U.S. dollar? Your reply seemed to say that international trade isn't enough to necessarily make a difference as hyperinflation is going to be a great kick in the guts to poor and middle class who couldn't/didn't invest in quality assets.
So a new question would be: if foreigners said 'we want you to pay us in Euros not your crappy U.S. dollars, would U.S. importers comply knowing that wealth redistribution caused by hyperinflation is affecting U.S. folks?
And are liabilities bad? I'd say definitely yes. A liability is something that is causing you a net loss. An asset conversly is something which gives a net profit. A computer which I'd use to play nothing but games on would a outright liability. But if I used a computer in my self-employment to make a living then it more than pays for itself and would be an asset. I'd say Robert Kiyosaki's (Rich Dad Poor Dad) definition of assets and liabilities are great eye-opener toward basic financial competency.
Published: January 26, 2007 11:14 PM
Sam:
in an honest money evironment:
-savings are good.
-liabilities are good only insofar you make assets more productive then creating real wealth.
- honesty and hard work are basic.
in a "inflationary " environment like the one we are living now:
- savings become the surest way of loosing your money.
- liabilities are good (or great)in the sense that you "short" a constantly depreciating money (you pay present money with a depreciated future money).
-and expertise in second guessing the central banker becomes the most important job skill anybody could have.
In a few words , it is pure PERVERSITY because you have no other choice than go with the flow no matter how wrong you see everything turning around you.
Thats is the reason you see now massive indebtedness all over, little savings , reckless expending that could become frantic as inflation accelerates (is the only real way for the small consumer to protect himself against inflation).
and yes , money can be made and by the ton if you know what to do and are willing and "capable" of leveraging your self to the "tilt". That is precisely what the hedge fund industry does with leverage that, unlike the old days when Rothbard complained of fractional reserves of 30% and so but, acts with massive leverage of 15 to 1 and 30 to 1 in some cases. and this is big and growing.(Goldman, 9.5 billions in net profits this year)
however , don't try this at home, this is only for the rich an knowledgeable with access to easy and cheap (free) credit . and unlike entrepreneurs in an "honest money" environment, these guys dont make money by creating wealth they create money by transferring it from those that don't count with the same skills. Remember, as Mises said, "money is not neutral" that is what is bad about inflation.
olmedo
Published: January 27, 2007 8:24 AM
Sam,
Having a liability-free production makes as much "sense" as consuming only what you produce. If you are poor on capital, but you have a great idea for some new products, would it make any sense to stay poor and not to borrow someone else's capital in order to create your fortune?
Liabilities per se are not the real issue here. The problem here is that some people get so hyped when they discover how useless and absurd any analysis based solely on trade balance calculation is - and they jump to a conclusion that current account balance does not matter. In other words, they are saying that constant net loss (not only liabilities) can be a great thing for an economy.
Imagine a firm that keeps loosing money, year after year, because it invests more in new technologies than it actually gains in assets. How would we rate its performance? There is a physical limit on how long a firm can endure a net loss, and at any rate, it is not a desired outcome (although it maybe an inevitable outcome of heavy investment in something that should produce an account surplus).
Some people also don't understand that this net loss in current account does not necessarily translate into a capital account surplus, because any capital acquisition (inflow) is balanced by an outflow of capital that was used in such purchases. In other words, you will have a capital account surplus only when the value of your acquired capital exceeds the value of capital that you lost - and current account deficits (net loss) cannot magically yield this outcome.
Published: January 27, 2007 11:45 AM
Sasha Radeta, huh? Are you confusing liabilities with expenses? I said any tool whether physical or financial that returns a net profit would be considered an asset. If I used debt as part of running a business and used that debt to make a business more profitable then that debt would be an asset to the business. If that debt was nothing but a burden and would ruin the business then it was a liability. Even if a entity has outgoing expenses if it helps to bring in more revenue it overall is an asset.
Published: January 27, 2007 7:30 PM
Sam,
Who is confusing expenses with liabilities? I apologize if I was confusing.
You stated this:
"And are liabilities bad? I'd say definitely yes. A liability is something that is causing you a net loss."
In other words, you viewed all liabilities as something that automatically reduces your profit (expense and nothing else). That is an incorrect view, since liabilities (obligations from past transactions) can be utilized for creation of new assets and they can produce profits (not just loss as you claimed).
You seem to have a strange definition of assets. As you know from the basic accounting equation, Assets = liabilities + owners equity. What any firm does with those liabilities will be reflected in its performance and on income statement. We all know that.
----
That is not the real issue here.
The real problem in our topic is not the question: "are liabilities bad". What Dr. Murphy seemingly suggested is that a net loss does not have to be bad. I tried to explain why current account deficit (outflow of financial assets, which is one part of our total capital) does not necessarily translate into capital expense surplus (just as net loss of a firm does not suggest increase in its total capital). I illustrated my position with some concrete examples.
Published: January 27, 2007 9:19 PM
In other words, there is no direct analogy between current account deficits (which can be viewed as an income statement issue) and capital account surplus (balance sheet issue). There is also no point in talking "are liabilities bad" (balance sheet issue again) in order to prove anything about current account deficits (negative income).
PS
Sam, only the fulfillment of liabilities can be viewed as an expense (that is when you no longer can use these assets). As long as you hold liabilities, there is no ground to claim that they will cause you a net loss, or net profit. They are just assets for all we know.
Published: January 27, 2007 10:12 PM
Well I just say this and no more Sasha Radeta, your definition of assets & liabilities are the standard bookkeeping version. Assets are something the business owns and a liability is that which the business owes money. Whereas Robert Kiyosaki's definition was in a financial/investment sense. Namely an asset provides a positive cashflow and/or appreciates ahead of its costs. And then a liability is one that causes negative cashflow and/or fails to rise in value ahead of the costs of buying and maintenance. Hence the old view of the home being an asset relied on the bookkeeper's version whereas in the financial/investment sense the home is a liability because it's costing you money to upkeep.
Published: January 28, 2007 12:09 AM
Sam,
I appreciate your attempt to reinvent accounting, but there is a good reason why liabilities are also recorded as assets (that is the only way to evaluate true potential of some firm, because liabilities can be utilized for production… of course, the ownership structure of assets is also very important and that is why we have ratios that measure liquidity and leverage).
At any rate, however you view liabilities that does not change that you were incorrect in stating that liabilities must produce a net loss.
Also, it does not change the fact that any discussion about “are liabilities bad” (balance sheet issue) is completely misguiding and useless in the contest of current account balance (income statement issue). Likewise, current account deficits (loss of capital in financial assets) cannot be equated with capital account surplus – because these deficits only represent the outflow portion of that account, without determining the value of capital inflow.
Published: January 28, 2007 12:41 AM
china doesn't need to dump/sell there existing reserves besides they won't find a buyer
the majority of there reserves are in SHORT -term bonds so they will let these mature and continue to DRASTICALLY CUT NEW PURCHASES
not sure what the lag time is between reporting of updated reserve totals but they will go down not from selling but from old bonds maturing and new bonds not being bought
Published: June 15, 2007 2:50 PM