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In the past few months, mouths much larger than ours have frighened the public once again with the issue of trade deficits. Are trade deficits really a sign that jobs and wealth are flowing out of the U.S. to foreign, and perhaps hostile, hands? The answer is an emphatic NO! To understand why trade deficits are not a sign of economic doom, ask yourself this: Don't you run a trade deficit with your grocer? Don't you buy a lot more from the grocery store than you ever sell them? If a trade deficit spells doom for the economy as a whole, why doesn't it spell doom for your household? You know why buying more from the grocery store than you sell them does not doom your family - because your trade is ultimately balanced. You sell your employer a lot more - in the form of your labor - than you buy from him. When you consider all that you take in and all that goes out - even if you save some of what you spend by sending it "out" to a savings account - you come out even. The same is true for the nation as a whole. There are two sides to trade, a "goods and services" account and a "capital" account. If we are buying more goods and services than we sell to another country, then they must be buying more capital from us than we buy from them. That is, they must be investing in our economy. Capital is the financial claims issued by the nation's households and businesses and includes both equity and debt instruments. To put it more concretely, if the workers at the Ford plant buy more Japanese stereos than Japanese workers buy American Fords then the difference must be made up in some way. If it does not come from selling more Fords to some other country then the Japanese must be investing in the U.S. They must be buying either equity claims (stock) or debt claims (loans) from Americans. Does that mean our economy can go dangerously in debt, like a family living off its credit cards? No. As long as government does not intervene and the market stays "free" - people trading because the trade is mutually beneficial, not coerced by government - two mechansims work to prevent a nation from "living beyond its means." These two mechanisms are the exchange rate of the dollar and interest rates. If foreigners are unwilling to buy financial claims denominated in dollars then the exchange value of the dollar will fall and the price of imports will go up, making domestic products relatively less expensive and reducing the trade gap. Also as foreign imports become more expensive, interest rates rise, which tends to slow down domestic borrowing but attract foreign capital to restimulate economic growth. When foreigners are very willing to buy U.S. financial claims, the exchange value of the dollar rises. As foreign imports become cheaper interest rates drop, increasing demand for domestic borrowing but making foreign investments in the U.S. relatively less attractive. To state these effects very simply, a nation cannot buy more goods and services than it sells unless foreigners view its economy as an attractive place to invest. When we have to worry is not when we run a trade deficit but when we are unable to do so. Back before economists figured all this out, nations followed a policy called "mercantilism." Nations wanted to be net exporters, reasoning that this would cause gold to flow into their economies and make them richer. It was largely the desire to follow this economic policy that caused Parliament to violate the "Laws of Nature and of Nature's God" by asserting absolute, arbitrary government control that led our Founding Fathers to declare independence. And isn't it the same today? The same politicians who try to frighten us with trade deficits are the very ones who want to assert absolute, arbitrary control over our property, to tell us who we can trade with and on what terms. Human nature hasn't changed much in 200 years, has it? |
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