Trade Deficit
A loyal reader asks: Is there an economically feasible way to run a country and maintain a trade deficit?
Trade theory isn't that complicated, but it is highly confusing to most journalists. The news recently has been rife with accusations that China is somehow destroying our economy by shipping us too much stuff. Other times, commentators bemoan how irresponsible America has been being by running up a huge trade deficit. Worry not dear readers!
Countries are not people. They can't owe anyone anything. When you buy some French wine, you don't owe France anything, but the purchase of wine results in an American trade deficit with France. You paid in full the moment you hand over the money to the store. They paid in full to the distributer, who paid in full to the winery. No debt at all anywhere in this picture, and no irresponsibility involved on any accounts.
The French wine makers do not get goods for the exchange, they get U.S. currency. They have three options: hold the currency, buy U.S. goods, or invest it in America.
1. Currency - All foreign held U.S. dollar count as our trade deficit. Since the U.S. dollar is the most popular reserve currency, our trade deficit is large.
2. American goods - If the foreigners want to buy U.S. goods, our exports grow and the trade deficit is eliminated.
3. If they purchase stocks or bonds in American companies (or government bonds), the trade deficit is not reduced. Any purchase of American capital by foreigners results in a larger American trade deficit. This quirk of accounting is the reason why the trade deficit looks so large. In fact, many economists think that a large trade deficit is good, because it shows that foreigners think there are a lot of good investment opportunities in your country.
So, is there any situation where the trade deficit is a bad thing? Maybe. If some of the capital foreigners buy is government debt, a large trade deficit may be a symptom of a large government debt. Foreigners may use their ability to stop funding our government as a method of controlling policy decisions. However, if the effect grows too large, the government can always default on the debt (refuse to pay it back). Overall, a trade deficit is a signal of strength, not weakness.
Can a currency keep its worth if there is no production base behind it?
No. The value of a currency is the value of the exports it can buy. American dollars only have value to the Chinese because the Chinese can buy things they want from American companies. If American firms cannot export anything of value, dollars only have value to U.S. citizens (who must use them to pay taxes).
However, if foreigners hold U.S. currency thinking our export capacity is 100, and it turns out to be 50, the exchange rate will adjust to a lower amount. There is nothing they can do, short of invasion that will recover the value of their imports. This is why I think China is so foolish to spend so much effort building up gigantic piles of green pieces of paper. When/if the U.S. dollar collapses, they will be left with nothing.
Trade theory isn't that complicated, but it is highly confusing to most journalists. The news recently has been rife with accusations that China is somehow destroying our economy by shipping us too much stuff. Other times, commentators bemoan how irresponsible America has been being by running up a huge trade deficit. Worry not dear readers!
Countries are not people. They can't owe anyone anything. When you buy some French wine, you don't owe France anything, but the purchase of wine results in an American trade deficit with France. You paid in full the moment you hand over the money to the store. They paid in full to the distributer, who paid in full to the winery. No debt at all anywhere in this picture, and no irresponsibility involved on any accounts.
The French wine makers do not get goods for the exchange, they get U.S. currency. They have three options: hold the currency, buy U.S. goods, or invest it in America.
1. Currency - All foreign held U.S. dollar count as our trade deficit. Since the U.S. dollar is the most popular reserve currency, our trade deficit is large.
2. American goods - If the foreigners want to buy U.S. goods, our exports grow and the trade deficit is eliminated.
3. If they purchase stocks or bonds in American companies (or government bonds), the trade deficit is not reduced. Any purchase of American capital by foreigners results in a larger American trade deficit. This quirk of accounting is the reason why the trade deficit looks so large. In fact, many economists think that a large trade deficit is good, because it shows that foreigners think there are a lot of good investment opportunities in your country.
So, is there any situation where the trade deficit is a bad thing? Maybe. If some of the capital foreigners buy is government debt, a large trade deficit may be a symptom of a large government debt. Foreigners may use their ability to stop funding our government as a method of controlling policy decisions. However, if the effect grows too large, the government can always default on the debt (refuse to pay it back). Overall, a trade deficit is a signal of strength, not weakness.
Can a currency keep its worth if there is no production base behind it?
No. The value of a currency is the value of the exports it can buy. American dollars only have value to the Chinese because the Chinese can buy things they want from American companies. If American firms cannot export anything of value, dollars only have value to U.S. citizens (who must use them to pay taxes).
However, if foreigners hold U.S. currency thinking our export capacity is 100, and it turns out to be 50, the exchange rate will adjust to a lower amount. There is nothing they can do, short of invasion that will recover the value of their imports. This is why I think China is so foolish to spend so much effort building up gigantic piles of green pieces of paper. When/if the U.S. dollar collapses, they will be left with nothing.