Learning to love the trade deficit Commentary: Any 'cure' would be worse than the disease

HEMPSTEAD, N.Y. (MarketWatch) -- Big as it is, our trade deficit is not necessarily a bad thing. Trying to force it down, however, could be.

It's been about a quarter of a century since we sold more goods to foreigners than we bought from them. In the intervening months and years, our trade deficit has grown markedly.

Fourteen years ago, it took an entire year for our monthly trade deficit to total $70 billion. Now we run up this much red ink in just one month.

Not surprisingly, our current account deficit, the shortfall on all trade and investment income we have with everyone else, has just hit another record. It's now more than six percent of our gross domestic product -- a number that has sent shivers up some spines.

Not mine. Call me Alfred E. Neuman if you want to, but my reaction is: "What, me worry?"

I'm not worried that we are buying more goods from foreigners than they buy from us. Nor am I concerned that these folks are in effect lending us money so we can buy their goods.

What would worry me would be efforts by Washington to try to force the deficit down.

Think of what would happen if we suddenly reduced our purchases of foreign goods. Growth in these countries would slow and unemployment would rise. Meanwhile, back in the United States, prices of the remaining goods would soar as domestic demand far exceeded supply.

Another side effect of a swift reduction in our trade deficit would be a drop in the number of dollars foreigners would have to buy U.S. stocks and bonds. This would result in lower stock prices and higher interest rates.

In my view there are two reasons why we have a trade deficit. The first is that we are growing faster than the rest of the world. The second is that the dollar is trading way above its intrinsic value in the foreign exchange markets.

Indeed, contrary to predictions by pundits, politicians and the press, the dollar has actually risen this year. If it was overvalued twelve months ago, it is even pricier today.

When the dollar (or any currency, for that matter) is overvalued, goods priced in dollars are expensive to foreigners, while goods priced in their currencies are cheap to us. That's why we buy more from them than they buy from us.

Some suggest that the reason for our trade deficit is that we don't save enough.

But in the short run, boosting savings means cutting spending. This might affect U.S. companies -- unless Washington were to erect barriers that would slow the inflow of goods produced in other countries.

This could very well lead our trading partners to retaliate by erecting barriers of their own. Before you know it, we'd be in a trade war.

As we saw in the 1930s, there are no winners in this type of war -- only losers.

Dr. Irwin Kellner is chief economist for MarketWatch. He also is the Weller professor of economics at Hofstra University and chief economist for North Fork Bank.

Well, if one takes a brutally materialistic view, we are printing pieces of paper that are only worth what people say they are worth (and which would be worth nothing were confidence to be lost in the US government), and for these pieces of paper we are getting stuff, real, material stuff of all kinds.

That seems like a pretty lopsided exchange in the US' favor. We need oil: other people pull it out of the ground. We give them pieces of paper. They give us the actual oil. We need chromium, and titanium, gold and germanium and neodymium magnets and every sort of Chinese trinket and Mexican pepper. And they give it to us. In exchange, we splash some green ink on pieces of paper and give it to them.

In the case of oil, in particular, whose sale is only denominated in dollars, when the British or French want to get oil on the world market, they have to take their own pieces of paper, which are must more regulated and restricted and stable, and buy ours so that they can buy oil.

Extraordinary, really.

If the US ever suffers a massive blow to its credit, though, there's a rather dramatic problem forseeable. American workers are so expensive, relative to cheap foreign labor, that the American industrial base - the thing that actually makes the STUFF we need and want - has collapsed. We buy most manufactured stuff from abroad now, with green pieces of paper.

If abroad stops trusting those green pieces of paper, we don't have anything ELSE we can give them in exchange. And we cannot replace the goods with domestic production.

So, the question is: can the US maintain the catbird seat, such that other people will give us real, material stuff in exchange for paper?

Brazil and other American countries give us an example of what the US can do if credit ever suffers, confidence is lost, and foreigners don't want those pieces of paper anymore.

At that point, we will have the stuff within the US, and they will hold debt instruments denominated in paper. So, you fire up the printing presses, print a lot of money, and pay off those paper debts. Of course such an act would destroy American credit, but the assumption is that the Americans wouldn't do it in the first place until their credit was already in the toilet.

What could put America's credit in the toilet?
Losing in Iraq.

We are OK.

We would remain OK. The only thing that can hurt us is the increased liberal-deficit-spending (even if its the Pubbies that are doing it).

If Govt. promises more than it can deliver, one day it would be faced with empty treasury and then Lord knows what they would do.

As far as Dollar being over priced, I disagree.

It is the ONLY currency of ANY value!

We are indispenseable Nation. The Europeans, or Japanese are simply not strong enough to replace either Dollar or us as Top Dogs.

Europe is aging, and their socialized economies can never grow as fast as our economy. They are pretenders.

Most importantly the spirit of innovation, the amount of resources focused on R&D (some individual Universities and Corporations have higher R&D budget than most nation's entire economies), the leading edge of technology is RIGHT HERE.

Japanese, Koreans, and now Chinese, have their entire economies based on the model to feed American consumer. They are very good and clever modifications, to AMERICAN INVENTIONS, and then selling them to us.

Who else can afford to find cure for cancer?

Cheap goods do us no harm. It only has side-effect of FORCING people to pursue higher skills. In my opinion, that makes us stronger (even if it means some people have to experience the pain of transition).

JMHO.

comments and analysis.

My take is that Kellner is right for the wrong reasons.

He's flat out wrong when he mindlessly blabs the conventional wisdom (now there's an oxymoron for you) saying that foreigners are "lending us money so we can buy their goods." The truth is that we're buying foreign goods with the profits we're making on stock, bond, and real estate deals with foreigners and it's high time the economics establishment got their collective heads out of their collective arm-pits and rewrote the whole 'trade-deficit' model.

Couldn't have said it any better.

My original post is answering your question.

It doesn't matter they don't like us, the fact remains, they can not do without us.

Everytime if there is even a hint of US withdrawal from ANY part of the world, don't you see people squirming everywhere complaing about the 'power void' it would create.

Who wants us to withdraw from Iraq? No one with IQ over 85.

In short, Our Credit is good!

Cheers!

US Bond is how we pay for it all. We pay REAL interest on that Bond with everything you said, but the ORIGINAL payment is a promise.

This is pretty much true when we're talking about the federal budget deficit. The trend for several years now has been to finance federal spending by borrowing more and more from foreigners. My take on that scheme is that if we really need to spend federal taxes on something necessary like defense, then fine with me. I say it's better to borrow from foreigners at 3 percent, then stick it to the US taxpayer who could be using that money to earn 10% with his stock investments.

But all this is not the same thing as the trade deficit. We're not borrowing anything to buy foreign goods-- we're selling things like buildings, stocks, and movie rights. IMHO this is what we're good at and frankly there's no stopping us.

"We are a wealthier and stronger nation, not manufacturing anything that we use. Or not."

We are for as long as people give credit to our paper so that we can buy what we don't make from them. After a certain time period, we can't make what we don't make anymore. If the credit falters, we can't buy it abroad either.

Perhaps most directly illustrative: It's cheaper to extract and ship oil from Saudi Arabia, where it practically bubbles at the surface, than to explore for it and pump it out of Alaska or even Texas. Producing less domestically and buying it abroad with fiat currency makes eminent sense. Until the credit gives out. Then you can't buy it abroad, and you don't have the domestic infrastructure in place to make it either.

Foreigners can do everything cheaper than Americans.
But there are, nevertheless, strategic industries which we should not ship offshore.

I think how they quantify the trade deficit is all wrong ...it is outdated. I would rather be the country that has enough money to buy from another country...

Current Account (trade) deficit is economic strength.

Remember and I were kicking this around a while back, and what we found was that very few in either the mainstream press and economics establishment saw it this way. This article here is one of the few I've seen that takes the view that Adam Smith was right 200 years ago and wrong now.

Smith saw how nations could either sell crops (good) or sell the farm (bad). He'd discovered that the trade balance was important and it meant a lot, then. Now it's stupid. When I buy controlling stock cheap in some failing French company, turn the business into a gold mine and sell it back the French at a huge profit-- I'm creating a trade deficit! Even though (like you said) I now have "enough money to buy from another country."

Like most economic measures, the trade deficit is imperfect and could likely be improved. However, I have seen no evidence that a significant part of the deficit is due to American businessmen investing in foreign companies, selling to make huge profits, and then using those profits to buy foreign goods. In fact, the Net International Investment Position of the U.S. is continuing to hit new lows as seen in the following graph:

The actual numbers and sources can be seen at http://home.att.net/~rdavis2/intinv.html.

no evidence that a significant part of the deficit is due to American businessmen investing in foreign companies, selling to make huge profits, and then using those profits to buy foreign goods. In fact, the Net International Investment Position of the U.S. is continuing to hit new lows

Thanks for responding on a Friday night-- this past week's been pretty hectic, but today I've been sitting around bored looking for some new way to get into trouble. ;-)

The last point on your graph is around -20% (down from -5% ten years earlier). That's

= (net international investment position) / gdp = (-2.5trillion/11.7trillion)

= [(US owned assets abroad) - (foreign owned assets in US)] / gdp

After an American businessman has sold a foreign company at a huge profit, the amount of "US owned assets abroad" is supposed to go down, and the US NIIP is supposed to "hit new lows". The BEA just updated the balance of payments --here's the press release that just came out and the trend is continuing. Description of the Balance of Payments from Wikipedia and with Investopedia.

Back in the early '60s the US was a creditor nation with exports that far exceeded our imports (by $5.1 bill ~1%gdp). We were in bad shape. That's because our capital exports ($7.6 bill.) were even bigger than our trade surplus so we ended up coughing up our gold reserves (@ $32/oz.). Unemployment was over 7% vs. today's 5%. The more I get into this, the more I come to the idea that maybe it's not the model that outdated. I'm thinking now that it's probably just the reporting that's so bad, and that's why we have the Freerepublic.

Thanks for responding on a Friday night-- this past week's been pretty hectic, but today I've been sitting around bored looking for some new way to get into trouble. ;-)

There's no trouble to be gotten into here on Freerepublic where we all debate rationally and treat each other with respect!

After an American businessman has sold a foreign company at a huge profit, the amount of "US owned assets abroad" is supposed to go down, and the US NIIP is supposed to "hit new lows". The BEA just updated the balance of payments --here's the press release that just came out and the trend is continuing. Description of the Balance of Payments from Wikipedia and with Investopedia.

Still, I see no evidence that a significant part of the continued drop in the Net International Investment Position is due to rich American businessmen selling foreign companies at huge profits. In fact, the data seems to suggest otherwise. Following is a segment of a table from http://home.att.net/~rdavis2/intinv.html:

INTERNATIONAL INVESTMENT POSITION OF THE U.S. AT YEAREND: 1976-2004
                       (billions of dollars)

     Net international  U.S.-owned        Foreign-owned
     Investment pos.    assets abroad     assets in U.S.
     -----------------  ----------------  ----------------
      Current   Market  Current   Market  Current   Market
Year     Cost    Value     Cost    Value     Cost    Value      GDP
----  -------  -------  -------  -------  -------  -------  -------
2000  -1381.2  -1581.0   6238.8   7401.2   7620.0   8982.2   9817.0
2001  -1919.4  -2339.4   6308.7   6930.5   8228.1   9269.9  10128.0
2002  -2107.3  -2455.1   6645.7   6807.8   8752.9   9263.0  10469.6
2003  -2156.7  -2372.4   7641.0   8296.6   9797.7  10669.0  10971.2
2004* -2484.2  -2542.2   9052.8   9972.8  11537.0  12515.0  11734.3

* preliminary

As you can see, U.S.-owned assets abroad are continuing to rise at a significant pace. The apparent reason for the drop in the NIIP is that foreign-owned assets in the U.S. are rising even faster.

The data in your post 16 are both consistent with and evidence of my observations of American business successes.

We've had some difficulty in connecting on this. What I have apparently failed to convey in my post 15 is that if Americans spend their days buying foreign stocks low and selling high, then the headlines would be (as you said) "U.S.-owned assets abroad are continuing to rise at a significant pace". If at the same time foreigners buy and hold US stocks purchased at high prices, then the news would also be "foreign-owned assets in the U.S. are rising even faster."

Other things that we'd expect to see along with "rich American businessmen selling foreign companies at huge profits" would be:

--US stock prices rising faster than foreign stock prices;

--US wealth increasing;

--More Americans able to buy more foreign goods than foreigners able to buy American goods.

Perhaps we'd be better off just watching the news to see if these other things are happening concurrent with the data cited in you post.

We've had some difficulty in connecting on this. What I have apparently failed to convey in my post 15 is that if Americans spend their days buying foreign stocks low and selling high, then the headlines would be (as you said) "U.S.-owned assets abroad are continuing to rise at a significant pace". If at the same time foreigners buy and hold US stocks purchased at high prices, then the news would also be "foreign-owned assets in the U.S. are rising even faster."

The headline "U.S.-owned assets abroad are continuing to rise at a significant pace" would only convey some combination of there being an increasing number of U.S.-owned assets and/or that those assets are rising in value. Likewise, the headline "foreign-owned assets in the U.S. are rising even faster" says only that the combination is even greater for foreign-owned U.S. assets. The headlines say nothing about clever Americans making big profits while stupid foreigners are sitting on overpriced U.S. stocks.

Other things that we'd expect to see along with "rich American businessmen selling foreign companies at huge profits" would be:

--US stock prices rising faster than foreign stock prices;
--US wealth increasing;
--More Americans able to buy more foreign goods than foreigners able to buy American goods.

Did you misstate the first item? The following graph shows the EWJ (iShares MSCI Japan Index), EFA (iShares MSCI Europe, Australia, Far East), and _GSPC (S&P) over the last five years:

As can be seen, both of these foreign stock indices have been rising faster than the S&P over the past five years. In fact, if you try other time spans at http://finance.yahoo.com/q/bc?t=5y&s=EWJ&l=on&z=m&q=l&c=efa&c=%5EGSPC, you'll find that they've risen faster in every time span under five years (2 years, 1 year, 6 months, 3 months, 5 days, 1 day). Only if you select max, does the S&P rise faster, due to its steep rise in the late 90s. In any case, it's interesting to note the the Japan index is the recent leader, rising about 15 percent in about two months.

You are absolutely right. It doesn't matter how much fun the party is eventually it has to end and the hangover is a bi*ch.

Oil is now moving into non dollar denominated currencies.

That means the end of $US as the worlds reserve currency which is why Japan, who owns the greatest amount of US debt, is buying heavily into gold.

Latest news. Japanese banks are allowing over the counter gold purchases.

Catch a cab, buy a coffee and sober up. The debt orgie is over.

--US stock prices rising faster than foreign stock prices... ...Did you misstate the first item? The following graph shows the EWJ (iShares MSCI Japan Index), EFA (iShares MSCI Europe, Australia, Far East), and _GSPC (S&P) over the last five years...

EFA and EWJ aren't indexes, they're exchange traded funds that started up recently. When people want say, a European stock index what we hear on the news is the FTSE (pronounced "footsie"). What we were talking about is whether the current account moves with a difference of stock prices or not. Look close at how the FTSE managed to keep up with US stocks back when the current account was zero, but it fell behind with the increase in the trade deficit.

The article for this thread centers on the idea that the trade deficit is OK --especially when you compare it to (heaven forbid) actually doing something about it. Greenspan said the same thing in London a week ago --

Whether by intention or by happenstance, many, if not most, governments in recent decades have been relying more and more on the forces of the marketplace and reducing their intervention in market outcomes. We appear to be revisiting Adam Smith's notion that the more flexible an economy the greater its ability to self-correct after inevitable, often unanticipated disturbances. That greater tendency toward self-correction has made the cyclical stability of an economy less dependent on the actions of macroeconomic policy makers, whose responses often have come too late or have been misguided.

The pundits all lied and came up with headlines like Greenspan: U.S. Deficit May Hurt Globally , or Greenspan Warns of Potential Severe Consequences Unless Budget Deficits Are Trimmed, but I've given up on pundits and prefer to simply read this stuff in the original.

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