America's Trade Imbalance: The Biggest Bubble of All Has Yet to Pop

Seeking Alpha ^ | February 20, 2011 | Ian Fletcher

[ianfletcher]

Americans presumably realize by now that living in a bubble economy, while exhilarating as long as the champagne lasts, is not a good move.

Therefore it is worth understanding why the biggest bubble of all may be yet to pop. I refer to America's trade imbalance with the rest of the world.

As I explained in a previous article, our trade deficit with the rest of the world means that we must a) borrow money and b) sell existing assets in order to cover the yawning gap between our imports and our exports.

And while a rich nation can indeed borrow a huge amount of money and has a lot of assets to sell off, this doesn't mean Santa has installed an ATM on every street corner. Which is what a lot of people seem to think.

Now it used to be that American liberals were the ones traditionally accused of "money-grows-on-trees" thinking. But I've noticed something: when it's convenient to them (i.e., not a matter of cutting social programs they don't like), American conservatives are now even worse.

Let's take as a case-in-point this recent assertion by Don Boudreaux of the libertarian Cato Institute:

Second and most importantly, Mr. Fletcher doesn't understand what a trade deficit is. An increase in the U.S. trade deficit does not necessarily mean that Americans are borrowing more or are selling off assets. The volume of productive capital assets is not fixed. Foreigners who invest dollars in creating and expanding businesses in America increase America's capital stock without either putting Americans further in debt or decreasing Americans' ownership of assets. Given that America is the world's leading destination for foreign direct investment, it hardly seems plausible that the U.S. trade deficit is evidence of American impoverishment or of inadequate production.

Now the key phrase here is, "The volume of productive capital assets is not fixed." The idea appears to be that because we can always make more assets, there's nothing wrong with selling them off to foreigners. Sounds logical enough.

The problem, though, is that even if you can bake more cookies, selling off the cookies you already have results in your ending up with fewer than you would otherwise have. Maybe you don't end up with nothing, but your still have fewer cookies than if you hadn't sold any.

The meaning of this analogy is that even if America can increase its stock of capital assets over time (as we obviously can), selling off some of those assets to foreigners still means we own fewer assets. Our net worth is still lower. We are poorer, by basic accounting. We own less.

Debt works the same way. Even if America's capacity to service debt goes up over time (as it does with a growing GDP), assuming debts to foreigners still means that we owe more than we otherwise would. Again, our net worth is lower. Our debit column went up.

Now let's look at the next tenet of bubble-think expressed above, the idea that "foreigners who invest dollars in creating and expanding businesses in America increase America's capital stock without either putting Americans further in debt or decreasing Americans' ownership of assets."

There are two problems with this idea.

First is that most foreign investment into the United States simply doesn't fall into this category. For example, of the $260.4 billion invested in 2008, 93 percent went to buying up existing companies, according to the Bureau of Economic Analysis. (Thomas Anderson, "Foreign Direct Investment in the United States," BEA, June 2009, p. 55.) Worse, a huge chunk of foreign investment in the U.S. just goes for Treasury securities, which get recycled, by way of deficit spending, into consumption, not even investment in existing assets.

Second, it's a baseline trick. It is indeed true that if we take our low savings rate as a given and ask whether we would be better off with foreign-financed investment or no investment at all, then foreign-financed investment is better. But our savings rate isn't a given, it's a choice, which means that the real choice is between foreign- and domestically-financed investment. Once one frames the problem this way, domestically-financed investment is obviously better because then Americans, rather than foreigners, will own the investments and receive the returns they generate.

Developing nations face this problem all the time (and more honestly than we do right now): While it's certainly nice to have foreigners come and invest in your country, because this creates jobs et cetera, what's even better is if you have the capacity to invest for yourself. Being able to develop your own country with your own investments, rather than depending upon others, is part of what distinguishes the serious players from the also-rans.

The last time America was importing huge amounts of capital was in the 19th century, when we were still a developing nation dependent upon European bankers to pay for building our railroads and the like; as we matured into a major industrial power in our own right, the tide reversed and we exported capital back to Europe to rebuild it, for example, after two world wars. In the 19th century, we borrowed to invest in projects that made us more productive, improved our capital stock, thus we could (and did) pay back the borrowing. Borrowing to consume is quite the opposite. Today, we are selling off our capital stock and damaging our future productivity.

The free trade crowd also assumes that the economics of trade takes place in a vacuum. This is where the golden rule applies: He who has the gold makes the rules and controls the key decisions. There are important economic and political consequences. If Washington is under the influence of Wall Street and so-called "American" multinationals, what will our policies look like, what freedom of action will we have as a nation? How does one possess national security when the economic sinews thereof belong to someone else?

At some point, all this will come out in the wash. Don't say I didn't warn you.

Ian Fletcher is Senior Economist of the Coalition for a Prosperous America, a nationwide grass-roots organization dedicated to fixing America’s trade policies and comprising representatives from business, agriculture, and labor. He was previously Research Fellow at the U.S. Business and Industry Council, a Washington think tank founded in 1933 and before that, an economist in private practice serving mainly hedge funds and private equity firms. Educated at Columbia University and the University of Chicago, he lives in San Francisco. He is the author of Free Trade Doesn’t Work: What Should Replace It and Why.

[FromLori]

Exporting Jobs

[ex-snook]

Trade means we buy product from you and you buy product from us. Trade is not we buy product from you in exchange for our factories, jobs and Treasuries.

15,000,000 unemployed marching on Washington will put Cairo in perspective.

[padre35]

Let us see if the Fleece Trade Troika would care to chime in on this issue.

[UCFRoadWarrior]

Interesting post...and well explains why having an extreme trade deficit like the United States has is disastrous for our nation.

I get a kick out of the extreme stupidity of Free Trade apologists who claim a trade deficit is “like the deficit you have with your grocery store when you buy groceries”. This stupidity demonstrates that supporters of our current Globalist sytsem have no understanding of real economics. Having a 20 to 30 billion dollar per-month trade deficit with Communist China is not something to be poo-pooed....it means that 20-30 billion of American wealth has left the shores.

Of course, if trade deficits were a sign of prosperity and economic success, most of Africa would be the economic engine running the world

Excellent post. Be prepared for flaming from Free Trade extremists

[NeverForgetBataan]

The trade apologizers can put up all the figures they want to about efficiency and other poo poo... but, I don’t beleive it and I NEVER believe anything that comes from the Commerce Department.

I only believe what people who actually work in the manufacturing industry tell me. And a friend who sells cold rolled steel is telling me right now that his sales are waaay down and he doesn’t see any indication that it will improve any time soon.

Does anybody here have ANYTHING that they can actually point to that really indicates that the economy is improving??

[gloryblaze]

Does anybody here have ANYTHING that they can actually point to that really indicates that the economy is improving??

I don't think there is anything to be found. Not to mention that I think there is more bad news beneath the surface, not talked about because if we really knew how bad it was, well...

I feel like I am in a bad dream. And I am not easily freaked.

[NeverForgetBataan]

“I feel like I am in a bad dream. And I am not easily freaked”
____________________________________________________________________________________________________________________

I agree.

[TopQuark]

Clearly you have something to say and what you say can be instructive. The article is rather problematic, however. I am not sure you can yourself answer the question what it's about. Half way through one gets a rather disappointing answer: someone else said something about you, and you don't like it. This places a reader in the middle of a fight which is neither his nor previously announced. The reader's felling of being used does not help you to be heard.

The article is almost entirely unfocused: you barely enunciate a premise and, without giving it its due, move on, leaving it largely unresolved.

Finally, you are sometimes technically incorrect --- in surprisingly uncomplicated matters. Specifically: "First is that most foreign investment into the United States simply doesn't fall into this category. For example, of the $260.4 billion invested in 2008, 93 percent went to buying up existing companies, according to the Bureau of Economic Analysis." It does not matter at all here whether the business is newly formed or existing. Consider a $10M firm which gets $10 investment (whether foreign or domestic). That investment will allow the firm to hire more workers, expand its phyisical plant, etc. You can think of it as two $10M companies under the same roof (what you apparently would prefer) or as one $20M company. Economists understand that whether these two are units of the same company or separate businesses does not matter (in macro sense, I am not talking about issues such as information and agency ere). You attack here injured your own foot.

There is one more comment I could make. You accuse the opponent of using a trick (a baseline trick), while it is you who are actually a guilty party. If you advance an argument in the original article, the onus is on YOU to make clear which baseline you use: the present level of investment or the future one in the absence of foreign equity. You have clearly failed to do so, and this article is nothing but a clarification. Well, you have not right, then, to accuse your opponent of misunderstanding economics. I am sorry you have not realized that failure even when pointed out, correctly and politely, by your opponent.

This last comment explains the feeling I got half way into the article: you are forcing me through a clarification of something that I have not read before, and you are doing so only because you've been caught by someone. What's my role en it? The present article is about you, not economics; it's about who said what and when.

P.S. The adoption of a hectoring tone (as in "you've been warned by Me The Omniscient") after being routinely imprecise in your logic and use of data does not help your credibility. If you want to do better next time, get down from your white horse and roll up the sleeves.

[expat_panama]

get down from your white horse and roll up the sleeves

Ain't gonna happen.  This is a delusion/feelings thread and the entire purpose is to provide a venue for people strutting on white horses and spouting nonsense about how great they are and how bad everyone and everything else is.

NeverForgetBataan and gloryblaze defies anyone to "point to that really indicates that the economy is improving".   OK, how's this for good news: for two years the trade balance is up from it's four years of all time lows.

Funny that, we get two years of trade balance 'improvement at the same time we get two years of high unemployment.   Let's face it, protectionists are career 'white horsers'.

[1rudeboy]

It’s true that one of the better ways to improve your trade balance is to go into a recession. Now, with oil approaching $100/bbl., if we ever get out of it we can pay more for it and add to the trade imbalance.

[NeverForgetBataan]

Well Expat... with all due respect to you, quoting some figures from Obozos Commerce and Labor Department is waaaay less than convincing for me. The cubicle mushrooms that cook up those charts don’t have to worry about where the next paycheck is coming from. It comes as a matter of course every two weeks from you and me.

To ignore high and persistent unemployment, and say it has no meaning, because we are still “trading” is a pathway to hell. It’s like playing Russian Roulette and denying that at some point the gun is going to go off.

We can’t link directly from Fox News, but you should head over there to read today’s article about Wally Worlds current sales slump... sniff sniff. Sorry.. I got a little
sad there for about a tenth of a second. Ok... I’m better now.

There’s allot of blah blah in the story about bad market strategy and other excuses. Unless you been livin on another planet for the past three years, anyone can see that their sales are down because people are buying LESS. They are buying less because they don’t have as much money. They don’t have as much money because they have had hours cut at work, they are unemployed and higher fuel prices are starting to restrict other discretionary spending.

Twenty years of the drunken outsourcing party in China is finally coming home to roost and we are waking to the bad hangover.

[Mase]

Well, of course you're right, but arguing with doomers and their fixed mentality is an exercise in futility. No amount of factual information will sway them from their self-inflicted depression.

Bataan doesn't like government stats. My guess is he'll reject statistical information from the conservative Heritage Foundation as well because they don't fit with his delusions of doom.

I'll try anyway:

Historically, it appears that when our trade deficit (current account deficit) increases the fastest, our employment, manufacturing and GDP grows the most. Conversely, as our trade deficit (current account deficit) contracts, so does our employment, manufacturing output and GDP.

Go figure.

[expat_panama]

Bataan doesn't like government stats

OK, he says he doesn't but if that were really true then he wouldn't care about well, the trade deficit.  The fact is the guy loves government stats, trade deficit, fuel prices, wages, all of them  --he's just not willing to do all the work of looking at them and tracking them over time.  After all it's so much easier to just say wages are down, fuel prices are up, without going to all the work of actually checking.

[NeverForgetBataan]

You’re right! I’m not convinced. The Heritage Foundation is a rubber stamp mouthpiece for free trade policy just like The US Chamber of Commerce and the National Association of Manufacturers.

But thanks for tying so hard. I don’t completely reject all free trade. I just don’t believe that because its called “free trade” that it is some kind of “wonder salve” that when applied, without care, will cure all ills like some kind of magic pixie dust.

My belief is that the cheaper cost of goods, from free trade, are like a “sweet spot”. It will benefit you, unless you take it too far.

[TopQuark]

Does anybody here have ANYTHING that they can actually point to that really indicates that the economy is improving??

Why do you need others? You know that the output (GNP) is increasing, i.e., the economy is growing.

[NeverForgetBataan]

I challenge you to read this and then tell me we have nothing to worry about, because free trade will solve all our problems.

http://seekingalpha.com/article/254119-3-things-to-do-as-you-watch-manufacturing-die-in-america

[gloryblaze]

Well, heck, actually I am a farmer with a lot of corn on hand, and it has become pure gold (except I see it and beans were limit down today n the CBOT - ouch). So, I’ll be OK, and that’s cool. But farmers are, what, 2% of the population? There are a lot of people suffering. Here and all over the world.

[TopQuark]

"There are a lot of people suffering. Here and all over the world."

There are plenty of people suffering all of the world, that is true, of course. But what is new? When people talk about today's suffering, they typically mean that there is more of it than before. Well, unemployment is about 10%, greater than 6% previously, so there are more people who have hard time making ends meat. But you also have to remember that many people that can't meet their mortgage obligations also tell everyone that they can't "make ends meat." It's not always true: the average house built over the last couple of decades is 40% larger than an average house built in 1950s, and the family is twice smaller. DO the math and you'll find that an average person today has almost three times more living space than his parents or grandparents. Living like a king is not the same thing as "trying to make ends meet." The point is, when we think of imprecise terms like "suffering" everyone can be included --- an Indian living on $3 per year with an American worker who makes $50,000 but has a hard time coming up with his mortgage.

But, going back to the original discussion, you seemed to view the economy as a completely dark cloud, with nothing going for it. That is why I replied: the economy is growing, and 90% of people are employed. My heart goes to those that suffer, but one has to keep things in prospective. Economically, the sky is not falling. Yet. (It may because of the socialist strangle on it, but we now have a divided Congress, so there is hope).

[gloryblaze]

I do think the Unemployment rate is actually above 10%, FTR. Notwithstanding that, no one is more glad than I that there is a bit of growth. No one is more glad then I that our state Governor, Walker in Wisconsin, is addressing out state fiscal issues. No one hopes more than I that it is not too late for the USA. But looking around, I am afraid the black swan is gathering strength.