Worrying About the ‘Trade Deficit’ Is Absurd to the Nth Degree

Cafe Hayek ^ | January 6, 2017 | Don Boudreaux

[expat_panama]

in Adam Smith, Balance of Payments, Myths and Fallacies, Trade

This post follows closely an earlier post from today. (I likely have used in the past a very similar analogy as the one I use here. Nevertheless, it works and is worth repeating.)

Suppose that we take all Americans whose last names start with the letter “N” and do an accurate accounting of this group’s spending and saving during some period (say, 2016). Further suppose that our accounting reveals that these “N” Americans earned, collectively, in 2016 a total of $750 billion, and that of this $750 billion, these “N” Americans spent only $700 billion on consumption goods and services. The remaining $50 billion was saved by these “N” Americans and invested in the non-“N” part of the American economy. Some of this $50 billion was used to buy real estate from non-“N” Americans; some of it was used to build factories and retail stores in parts of America where no “N” Americans live; some of it was used to buy ownership shares of firms and of capital goods from non-“N” Americans; some of it was loaned to non-“N” Americans; and some of these dollars were simply held by these “N” people in their purses and wallets and piggybanks.) Non-“N” Americans did no similar investing in the “N” part of the American economy.

The “N” Americans, in 2016, ran a trade surplus with non-“N” Americans, and we non-“N” Americans ran a trade deficit with the “N” Americans! (Note that, inessential details aside, there is nothing at all implausible about this story. It very well might be the case that “N” Americans ran in 2016 a trade deficit with non-“N” Americans.)

Should we non-“N” Americans worry about our trade deficit with “N” Americans? Should we non-“N” Americans stop, or at least reduce, our trading with “N” Americans? Should we worry that “N” Americans are harming us non-“N” Americans by investing more in the non-“N” part of the American economy than non-“N” Americans are investing in the “N” part of the American economy? Should we conclude that “N” Americans are trading “unfairly” with non-“N” Americans?

Of course not. It would obviously be absurd to harbor any such worries or to draw any such conclusions. The “N” Americans’ net saving and investment not only do nothing to prevent us non-“N” Americans from saving and investing as much as we wish, but the “N” Americans’ saving and investing enrich us all – non-“N” and “N” alike – by making the economy of which we are all a part more productive.

And yet, when people fret about an American trade deficit, such worries and conclusions are drawn. But these worries and conclusions make no more sense than they would in the context of “N” and non-“N” Americans. Fretting over the trade balance is absurd. Again, Adam Smith nailed it:

Nothing, however, can be more absurd than this whole doctrine of the balance of trade.

[riverdawg]

The BLS published an article in December 2015 in its Beyond the Numbers series that breaks out the out of the labor force total by “reason.”. Just under half were retired, as I recall, with home responsibilities, schooling, and “I’ll or disabled” the other contributing categories. Thebdatabwere from 2014.

[expat_panama]

...we are exchanging Chinese ownership of US assets, land, companies for cheap stuff from China...

Thank you so much, this is exactly what I have been trying to get across to odawg and TwelveOfTwenty but instead of admitting that what you're saying is true they just change the subject from trade to my being a bad guy ("you are insane").

What I got from your post is that while Americans get rich trading assets, land, and companies with each other, but we lose our shirts if we trade w/ the Chinese.  While this is easy to say it's a lot harder to see in real life.   The fact is that when Americans buy and sell assets, land, and companies we get more rich when the market expands internationally:

<-- [click to enlarge]

Let's face it, when we buy and sell assets we profit no matter what the left says; mostly because Americans are smart but also because money-losing Americans go out of business.

So let's use the example you offered w/ China --even though our biggest trading partner is Europe followed by Canada, but China is more fun: 

[personally I always liked the dragon lady more but no matter]

Last Feb. I bought Alibaba (BABA) on margin for $50/share and then I sold it in Aug for $100/share, and then I traded the wealth I created for bars of gold that was mined in China.

That's what a trade deficit in goods and services is, in Jan. I got nothing and in Sept. I'm rich. It's what happens with a 'financial surplus'. 

[ModelBreaker]

Expat:

Good thoughts about financial surplus. It’s great to dominate the world in banking and have that surplus. But it’s not great to have that such a huge comparative advantage that you hollow out manufacturing.

Some of that is going to improve naturally as long as we keep the green crazies away from fracking. Our comparative advantage in energy costs (esp natural gas) is going to be a big deal over the next 20 years that will benefit manufacturing and Americans across the board, as long as we don’t toss the advantage away with stupid asymmetric trade deals.

[expat_panama]

...financial surplus...   ...you hollow out manufacturing...

The hell it does.  

We covered that way back in post post #32 that whenever we get a financial surplus/tradedeficit we also get more U.S. factories.  We can say want we want but we all saw that the facts are that manufacturing employment/production soared when the TD grew, and in '09 the TD shrank and our factories got boarded up.  This in turn was followed by years of a growing trade def. plus a resurgence of  mfgr empl/production.

Sure, everyone says that a TD will 'hollow out manufacturing' but reality says the opposite.  We'd all be a lot better off if we simply accepted reality on its own terms and ignored what 'everyone' says.

[Alberta's Child]

It also dramatically reduced theft at U.S. ports.

[Alberta's Child]

Right — all good points. The difference is that the U.S. is in a much better position than anyone else today when it comes to maintaining a global reserve currency. That may change over time, but for any reasonable investment horizon it would be hard to ignore this.

[Alberta's Child]

Don’t compare the U.S. today with the U.S. in a period when we were the only major industrial power that hadn’t been decimated by World War II. You’re going to end up making incorrect conclusions about cause-effect relationships if you do that.

[Alberta's Child]

Low workforce participation benefits no one and it is a result of our manufacturing base being shipped overseas.

One of the biggest factors in our low workforce participation rate is the sheer number of Americans who are retiring on an ongoing basis. I don't see how this relates to our manufacturing base.

[alexander_busek]

The difference is that the U.S. is in a much better position than anyone else today when it comes to maintaining a global reserve currency.

Yes, that is, of course, why the U.S. dollar is the global reserve currency - and not, e.g., the Mexican peso.

"Volume" also has something to do with it.

But those observations don't change the fact that the U.S. dollar is merely the "dog with the fewest fleas."

Regards,

[TwelveOfTwenty]

We covered that way back in post post #32 that whenever we get a financial surplus/tradedeficit we also get more U.S. factories.

You never did answer my call to offer up the numbers supporting that graph, but here's one reason the deficit dropped during those times, and it has nothing to do with fewer factories.

[TwelveOfTwenty]

Thank you so much, this is exactly what I have been trying to get across to odawg and TwelveOfTwenty but instead of admitting that what you're saying is true they just change the subject from trade to my being a bad guy ("you are insane").

I never called you insane, but if you're going to make blanket statements like that, then I can understand why someone else would.

What I got from your post is that while Americans get rich trading assets, land, and companies with each other, but we lose our shirts if we trade w/ the Chinese. While this is easy to say it's a lot harder to see in real life.

It's easy to see in the closed factories and Americans working multiple part time jobs saying "Fries with that?" instead of full time manufacturing jobs with benefits.

The fact is that when Americans buy and sell assets, land, and companies we get more rich when the market expands internationally:

That's only true because we're building up their economy with our consumer dollars.

Last Feb. I bought Alibaba (BABA) on margin for $50/share and then I sold it in Aug for $100/share...

The Chinese military thanks you for supporting the economy that finances it.

[Alberta's Child]

A sobering view of the U.S. situation for manufacturing labor was posted here and discussed at length last month:

Work without Men

This piece includes some very interesting items about the number of open manufacturing positions in the U.S. today (the highest level in 15 years), and forecasts for up to two million unfilled manufacturing jobs over the next decade.

[CodeToad]

” I have a trade deficit with my local grocery store.”

No, he doesn’t. That is a ridiculous analogy. Neither he nor the grocery store has any debt to the other.

[odawg]

None of you strange people who have managed to overthrow common sense by reading an article or two about the desirability of a trade deficit or the harmlessness of a trade deficit by some professor who lives with his head up his ass, and not in the real world, have yet to explain why all other nations like China, for example, bend over backwards to avoid a trade deficit, or why they are not in competition to create their own trade deficit, or why they are not in a rush to build their factories in the United States.

As for what they do with their dollars, they are buying American real estate, Hollywood, the Panama Canal; they already have bought all the movie theater chains in the United States, building a top rate military, building up their nation; other assets around the world.

[Alberta's Child]

I don't know what "real world" you're talking about. Perhaps you can tell us how many people you employ in your business.

I have a simple question for you.

In 1994 -- the year NAFTA was fully implemented -- the U.S. exported $50.8 billion worth of manufactured goods to Mexico, and imported $49.5 billion of manufactured goods from Mexico. In manufactured goods, we had a trade surplus of $1.3 billion with Mexico.

In 2015 -- the last year with full-year figures published -- the U.S. exported $235.7 billion worth of manufactured goods to Mexico, and imported $296.4 billion of manufactured goods from Mexico. In manufactured goods, we had a trade deficit of $60.7 billion with Mexico.

By any objective economic measure, was the U.S. better off in 1994 or in 2015?

[Alberta's Child]

As for what they do with their dollars, they are buying American real estate, Hollywood, the Panama Canal; they already have bought all the movie theater chains in the United States, building a top rate military, building up their nation; other assets around the world.

I seem to remember hearing the same thing back in the 1980s when it was Japan, not China, who was doing all this.

It reached a peak in 1989 when Mitsubishi paid $850 million for a controlling stake in Rockefeller Center in New York City. By 1995 they filed for bankruptcy protection, and Mitsubishi ended up writing off about a $1.8 billion loss on its books when it bailed out of the asset.

[JediJones]

Producing is completely different from manufacturing. Manufacturing is low-level grunt work that we would do well to export overseas to uneducated third-worlders or design a machine to do for us. Those jobs should be thrown into the dustbin of history just like we have constantly done over the years with manual labor-intensive jobs.

The country that actual INVENTS and DESIGNS new products is the powerful country. That is what we are in constant competition with other countries to do and where we continue to hold a massive advantage.

Actually building and manually assembling those designs is useless and irrelevant. If the countries we export that grunt work suddenly blow up tomorrow, we could easily start up a factory to get that work done here in a very short time. In the meantime, we are much better off taking advantage of the cheap foreign labor or even better building machines to replace those jobs permanently, as every industry has tried to do from the beginning of time.

Economic progress is defined best by ELIMINATING the need for and the corresponding cost of labor. Eliminating jobs and/or reducing the cost of labor is what radically lowers the price of goods and increases the standard of living for everyone.

[JediJones]

China’s economy already entered into a decline last year. The paranoia that they will “take over,” a la the same paranoia about Japan in the 1980s, is already fading fast.

It appears in some ways their economic growth has been a fraud based on their government cooking the books. You can’t trust a communist regime.

[JediJones]

A trade deficit has NOTHING to do WHATSOEVER with “debt.” You need to do a lot more reading and boning up on basic economic principles and terminology before you contribute to a thread like this.

The article’s author is exactly right and you couldn’t be more wrong.

[Jim Noble]

“Bad analogy. A nation is not a randomly selected group of people whose names end in the letter N.”

Bravo!

Libertarianism is SO over.