Cafe Hayek: Why we trade

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November 13, 2007

Why we trade

Russell Roberts

Here's my attempt in about 1000 words to explain the relative importance of imports and exports and the total unimportance of the trade deficit. I wish there had been room to talk about the human side of trade. The creation of prosperity is an important part of why we trade but not the only reason.

The whole story is here.

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Comments

Thanks for the essay. I have added it to the required reading for my undergrad course in international business.

Posted by: Acad Ronin | Nov 13, 2007 10:15:15 AM

Thanks. I enjoyed reading this.

I had never before thought about how many jobs are eliminated every quarter and how many are gained. It puts the whole offshoring job loss argument into proper perspective.

Posted by: John Dewey | Nov 13, 2007 12:14:00 PM

While I fully agree that we benefit from each direction of trade, it seems to me that there are negatives to a long-running trade deficit. In particular, it appears to be driving down the exchange rate, which produces inflation by raising the price of foreign goods.

For those who care, the purported mechanics are approximately this: a trade deficit means that the net flow of US Dollars is out. Over decades of a trade deficit, dollars accumulate in foreign countries. The foreign countries generally use these dollars buy US debt (typically government bonds and mortgage-backed securities.) However, (1) the US is issuing fewer new bonds as the budget deficit falls, (2) nobody wants mortgage-backed securities, and (3) eventually, as we see in China, large holders avoid currency risk by diversifying their holders.

The net result is that there are a lot of US dollars held by foreigners, who do not have much demand for more of them. Accordingly, the price (i.e. the exchange rate) drops.

(Note: I don't know enough macroeconomics to know if this is rubbish or not, but it seems to make sense.)

Posted by: Chris | Nov 13, 2007 4:14:59 PM

Chris,

To simplify the situation a bit, why do I care who makes my shoes? If a guy I don't know in China makes the same pair of shoes for less than a guy I don't know in Ohio, it seems obvious to me that I'm better off if I buy from the guy I don't know in China. And if the circumstance change to make Ohio shoes a better deal, then I will just as readily buy Ohio shoes. So it seems to me that all this talk of trade deficits is completely irrelevant. Unless, of course, there is some sort of war going on that I don't know about - and if there is, I strongly doubt that I or the shoemaker started it.

Posted by: Randy | Nov 13, 2007 5:16:47 PM

Randy --

I completely agree with you about the shoes -- I see no particular reason to buy American just for the sake of buying American, and plenty of reasons why the country of origin should make no difference. (With few exceptions -- the Cuban Embargo, for example.)

My problem is that a long run of trade deficits, when combined with other current economic factors, has crushed exchange rates and dramatically lowered my buying power. I am worse off when the Swiss watch I could have bought two years ago for $100 is now $150, or the barrel of oil that was $66 is now $100.

Now, I suspect that the trade deficit will slowly correct itself. As the exchange rate drops even further, US products will become cheaper to foreigners and foreign products will become more expensive to Americans. In 20 years, the balance may be reversed. But, the US will have been made dramatically poorer as a result.

Posted by: Chris | Nov 13, 2007 10:56:23 PM

Chris,

The U.S. has had a merchandise trade deficit for 32 years. We've had strong dollars and weak dollars over that same period. Why do you feel that the situation is any different today than say, the mid 80's, when the merchandise trade deficit was about 3.5% of GDP?

Are you sure that the trade deficit is causing the price of oil to be $100? Why isn't it Chinese demand and political uncertainty that's causing $100 oil? Or Federal Reserve rate reductions?

Posted by: John Dewey | Nov 14, 2007 7:08:19 AM

Chris,

I'm a bit weak on the monetary stuff (okay, a lot weak), but it seems to me that the reason the dollar falls is because the US government is making too many of them. If that's correct, then I can see a possible tie in to trade deficits. If the government tries to assist those who lose out to foreign competition by throwing new dollars at them, rather than allowing them to come up with better ways to use resources, then yes, the dollar falls and we get poorer. So, if I'm still on track, the problem is not the foreign competitors, but the belief that people shouldn't be allowed to fail. Savvy?

Posted by: Randy | Nov 14, 2007 8:03:16 AM

It seems to me that the deficit is not a problem in itself. The rising prices in itself as a response to a hurricane are not a problem. They are a symptom. Thus on free markets the deficit is a symptom of some underlying cause. Looking at the size of the US deficit, it seems to me very improbable that on free market people would voluntarily do actions that would produce such outcome. Not impossible, but very improbable. Considering, that the USA does not have a free market, people might have chosen to run the deficit because of the state intervention. In such a case it may be a symptom of a problem - people acted against their best interest because of the intervention.

The deficit in itself is not a problem, but a symptom. The solution is not to treat the symptom, but deal with the problem. If there is no problem - the better. But the logical jump from "deficit in itself is not a problem of free market" to "deficit never signals a problem" seems to me too long.

Posted by: andy | Nov 14, 2007 9:38:14 AM

"The deficit in itself is not a problem, but a symptom."

Yes. The trade deficit is a "symptom" of the strong U.S. economy.

As a percent of GDP, the U.S. trade deficit declined sharply in 1981-1982 and 1990-1991. It declined slightly in 2001. None of these years were economic boom years.

As a percent of GDP, the U.S. trade deficit grew strongly in 1984-1987, in 1999-2000, and 2003-2006. These were all periods of strong economic growth.

During economic booms, U.S. consumers spend more on imports. No surprise there.

Posted by: John Dewey | Nov 14, 2007 10:05:35 AM

John --

Like I said, I don't understand all the economics. I would suggest, though, that in the mid-80's, we were running budget deficits which were much higher than we are running now. So, when foreign countries were awash in US Dollars, they could invest them in US Government Bonds, a nice safe place to put them that earned a decent rate of return.

Re: your question about oil. Oil is clearly expensive (relative to historical prices) because of demand and other factors. But, I suggest that if the dollar were stronger, it would not be *as expensive* as it is in the US now. In the past 4 years, the value of the Dollar has dropped by about 1/3rd. As a result, nearly everything (including oil) that we import is more expensive than it would be under a higher exchange rate.

Randy --

I'm very weak on it also and I wish somebody would step in with a suggestion about how to get stronger, (preferably one that doesn't involve going back to school). In general, I agree with you, but I would refine the model -- dollars are cheap, not because there are too many made, but because there are too many in circulation among those who would buy them -- foreign interests. It's not the act of printing that causes problems -- it's putting them in circulation.

Posted by: Chris | Nov 14, 2007 10:11:19 AM

John, I think you would probably find many other countries that went through the boom (I didn't see the data, though China would probably be one example) that actually run trade surplus. Please, can you explain, how is it possible?

The current account deficit has nothing to do with economic growth. It has everything to do with investement, borrowing and lending. There are 2 possible interpretations: Either the US was borrowing for the last 20 years for consumption, or for investment. Considering the huge government debt which goes to consumption, I would bet for the second option.

Posted by: andy | Nov 14, 2007 10:14:09 AM

Chris...
"It's not the act of printing that causes problems -- it's putting them in circulation."

The purpose of printing money is obviously to put it in circulation....I doubt the Fed print it to be on display in their nice building :)

Posted by: andy: | Nov 14, 2007 10:19:34 AM

andy: "The current account deficit has nothing to do with economic growth."

I disagree. When the U.S. economy contracts, consumers have less to spend for imported goods. At the same time, U.S. investments are not as attractive.

This view of trade deficits and economic growth is certainly not just my own.

Daniel Griswold, director, Center for Trade Policy Studies, Cato Institute:

"An examination of annual changes in the current account balance compared to economic growth since 1980 shows that a "worsening" deficit is typically associated with faster economic growth, and an "improving" deficit with slower growth."

"Recessions tend to dampen demand for imports. During each of the three most recent recessions, imports as a share of GDP have dropped sharply."

"When GDP growth accelerates, so does domestic investment, inflows of foreign capital, and the current account deficit. While a growing current account deficit is not the cause of faster GDP growth, it is often its handmaiden."

Economic growth and trade deficits

Posted by: John Dewey | Nov 14, 2007 10:55:14 AM

John, I think that the study is parallel to my argument. I will give you another argument from another country.

The question is: does huge investment cause huge inflation? The answer is - on free market probably not significant, as influx of money would be soon used on greater imports. Investment in real terms means imports. In a country with floating exchange rate huge investment would result in appreciation and the deflation of import prices would mostly offset the domestic inflation.

Now you make a study of a country on fixed exchange rate. What do you conclude? That investment DOES cause inflation, because the central bank is forced to print domestic money in response to greater demand.

Does from this follow that investment is bad? No. But it is fallacious to conclude that inflation is not bad, because it is the natural outcome of investment. Actually, the fixed exchange rate is the problem and inflation is a symptom - the actual link investment-inflation is a symptom.

Back to the US: the GDP-deficit link may be a symptom of current monetary policy. The current monetary policy is anything but free market. The deficit thus may be a symptom of bad monetary policy. You would have to prove that the GDP-deficit link is not influenced by monetary policy. In my opinion, it is influenced.

Posted by: andy | Nov 14, 2007 11:21:01 AM

Sorry, Andy, but I've read your post twice and I don't understand very much of it.

I think I do understand what Mr. Griswold, Professor Boudreaux, and Professor Roberts have written about trade deficits.

Have you published a paper about this subject? I'm willing to read a short and try to understand your thoughts.

Posted by: john dewey | Nov 14, 2007 11:42:12 AM

A weak dollar does not cause inflation. Inflation is an increase in the general price level. A weak dollar will change the relative price of foreign goods compared to domestically produced goods, but does not effect the general price level. Relative prices of various goods are constantly changing even in an economy with no inflation.
The existence of a trade deficit can be a sign of a strong economy. As I recall from my international economics course I took long ago, there are two accounts that need to be considered. The trade account (the exhange of goods and services) and the capital account (the exchange of capital assets such as bonds, stock, real estate, etc.) The relationship between the he trade and capital is an accounting relationship, which must always balance. So when there is net foreign investment in US assets because foreigners believe the US economy is strong and politically stable, this will necessarily cause offsetting trade account deficits.

Posted by: PaulD | Nov 14, 2007 1:28:12 PM

Raymond J. Keating, chief economist for the Small Business & Entrepreneurship Council, explains very clearly the relationship between economic growth and the current account deficit:

"Trade deficits usually reflect economic growth. A growing economy attracts foreign investment and boosts the demand for imports by both individuals and businesses, with the result being a trade deficit. When you look back over the past several decades, it is interesting to note that during periods of robust U.S. economic growth, U.S. trade surpluses shrink or deficits expand, while during economic slowdowns or recessions, trade deficits either get smaller or shift to surpluses."

The Facts on Trade and Jobs

Posted by: John Dewey | Nov 14, 2007 2:34:46 PM

Would somebody be able to answer this question at the level of a lay person (someone who does not understand economics).

Consider two buckets of money. Let us call one U.S. and the other ROW (rest of the world). If more money is going out of the U.S. bucket and into the ROW bucket, how can this happen unless 1) assets are being sold/mortaged or 2) the size of the U.S. bucket is increasing every year due to dynamics within the U.S. bucket (or of course both 1) and 2) ).

If the reason is 2) does this not become a problem/unsustainable at some point? If the reason is 1), is there a way of measuring that?

Thanks

Posted by: Mark Seery | Nov 14, 2007 3:28:28 PM

Mark Seery,

I'm not an economist, so perhaps I can only offer a layperson's opinion.

I think U.S. assets have been increasing by $3 trillion to $4 trillion per year, if I understand correctly the numbers I've read. I cannot see why it makes any difference to the U.S. economy - or to U.S. households - if foreign investors and foreign governments either create or acquire some fraction of that asset growth. A trade deficit of $800 billion is just a fraction of U.S. asset growth.

Consider that some of the assets owned by foreign corporations are actually created by those foreign corporations. The new Honda plant in Indiana is one example of many such assets.

As Mr. Griswold and Mr. Keating pointed out, the trade deficit actually reflects the perceived strength of the U.S. economic engine. Foreigners are creating/buying both physical and financial assets because they have confidence in the U.S. economy.

Posted by: John Dewey | Nov 14, 2007 3:52:41 PM

Thanks John, I appreciate your viewpoint.

Do you know if there is an econometric that best reflects to annual growth of asset value? / how did you come to understand this growth yourself.

Thanks again...

Posted by: Mark Seery | Nov 14, 2007 4:23:15 PM

"Yes. The trade deficit is a "symptom" of the strong U.S. economy."

Bingo.

Posted by: Simon Clark | Nov 14, 2007 4:30:09 PM

Mark Seery,

Here's a link to a Federal Reserve page that shows the total assets owned by households and non-profit organizations.

Balance sheet of households and non-profits

As you can see, I understated the annual growth in U.S. assets, which has averaged over $5 trillion since 2002.

I have read arguments that this growth is simply the result of the real estate bubble. But the data show that the growth in financial assets - including stocks, mutual funds, pension reserves, and unincorporated businesses - was twice that of real estate growth.

Posted by: John Dewey | Nov 14, 2007 4:42:14 PM

John,

It is interesting to note that based on those numbers, liabilities grew faster than assets, and assets of course grew faster than net worth, in 2004,2005,and 2006. Only slightly though, and net worth still grew much more than inflation it would seem.

So net worth continues to grow, with what appears to be a small amount of leakage (liabilites growing faster than assets). Looks like this may not be the case from the first 2 qtrs of 2007 data though.

Posted by: Mark Seery | Nov 14, 2007 5:27:45 PM

PaulD --

Why does a declining dollar not lead to inflation? As you pointed out, it causes prices of foreign goods to go up. But, I don't see any story that says that it makes the prices of domestic goods go down. In order for the general price level to remain constant, the increases in prices of foreign goods would have to be offset by price-cutting of domestic goods.

In fact, I suggest that in markets dominated by foreign firms, the price of domestic goods might go up as well -- if you're forced to price at the level dictated by competition, when your competition raises prices, you can too.

Posted by: Chris | Nov 14, 2007 5:40:29 PM

No I haven't :) I'll try again.

The paper you linked to shows that under current monetary system (which is not free-market based, it is Fed with fed-fixed interest rate) the deficit is correlated with growth.

The study did not show that under free-market based monetary system the same would apply. It seems to me very improbable that under free-market based monetary system such a deficit would occur.

Example: the Chinese government holds paramount amount of US dollars, bonds etc. Such decision would probably not be made by any profit-oriented enterpreneur in free market economy.

If the chinese did not buy USD reserves, they would have to float the yen, dollar would sharply depreciate and this would work to reduce the deficit.

My opinion how to describe the deficit is this...but I am just a poor amateur :)
The FED made interest rate 1%. People started to borrow more money - and buing more goods from China. China has fixed exchange. When they receive USD, they put it in the reserves and print yens, which they pay to their producers. This goes on for several years.

Results:
- the US citizens have no savings (1% interest? why save)
- the US citizens are completely in debt (1% interest? why wouldn't you borrow)
- the US has huge trade deficit particularly with countries that pile up USD reserves (China in particular)
- China is facing inflation problems because of the printed yens,
- China cannot get rid of their USD reserves if they want to keep the fixed exch. rate....because China announced that they are going to diversify reserves, that would mean that they would have to break the link with dollar

Seems to me that pretty much describes the current state of the US economy...

Posted by: andy | Nov 14, 2007 6:48:45 PM

The interesting thing about deficits is that all countries just cannot have deficit. You know, some must have surplus. And considering that all the world is full of countries with roughly the same growth as the USA - why those countries do not run SUCH deficit?

The problem is that you look past several DECADES. You must look past the Fed management of the economy, somewhere to 1870-1910. I am very much sure the USA did not have so huge deficit in those years.

Posted by: andy | Nov 14, 2007 6:58:43 PM

Andy :"The interesting thing about deficits is that all countries just cannot have deficit."

The U.S. does not have a overall deficit, Andy. It has a current account deficit and a capital account surplus. All that means is this:

1. Americans buy $x of Rest of World (ROW) goods and services;

2. Americans buy $y in ROW capital investments and other financial assets;

3. ROW buys $(x-$800 billion) American goods and services;

4. ROW buys $(y+800 billion) in American capital investments and other financial assets.

Thus, the U.S. has an $800 billion current account deficit and an $800 billion capital account surplus.

You can argue all day and all night about why ROW would rather make more capital investments and buy financial assets. If some want to invest in the strong U.S. economic engine - if others want to finance our government spending - that's fine with me.

Note, I am not saying that out of control U.S. government spending is fine with me. But given that it exists, I just don't care who finances it. Do you?

Posted by: John Dewey | Nov 15, 2007 3:06:10 AM

Mark Seery: "Liabilities grew faster than assets, and assets of course grew faster than net worth, in 2004,2005,and 2006."

I'm not sure what you mean. Are you referring to percentage growth?

In 2004 through 2006, U.S. household:
- assets grew $15.4 trillion;
- liabilities grew $3.5 trillion;
- net worth grew $11.9 trillion.

IMO, the most significant fact one can derive from the table I linked to is this:

Net worth of U.S. households increased 27% over the past three years.

So why isn't this fact being celebrated in the mainstream media?

Posted by: John Dewey | Nov 15, 2007 3:28:35 AM

John...of course I know that the overall trade balance is 0. I was referring to the fact that all countries cannot have current account deficit. Some must have current account surplus. That's where the study is wrong, because they based their results only on the US economy - and not on the rest of the world as well - which is certainly not performing worse then the US.

I would personally see the reason of the deficit in the COW central banks buying US 'assets'. And the 'symptom' it shows is: If the US was not financed by foreign governments, they would have to curtail consumption (which would have lowered the quality of life).

I am personally opposed to call government bond a 'capital investment'. In my opinion, more grounded interpretation would be that China has lent money to the US for consumption. I found borrowing for consumption 'bad practice' even in free market. If you encourage people to do something, more of them will do it. Even if it is in the long run bad idea. The US and Chinese government encouraged people to do stupid things - to get indebted. And the deficit is the account.

Posted by: andy | Nov 15, 2007 4:05:53 AM

Oops...ROW central banks, not COW central banks ;)

Posted by: andy | Nov 15, 2007 4:09:03 AM

Andy,

The U.S. government will spend more than it takes in whether the Chinese buy T-Bills or not. U.S. government deficits have been around far longer than trade deficits with China.

If the Chinese did not buy T-bills, they would have to use their dollars for something. They could buy U.S. goods and services. They could invest in U.S. equities. They could build plants in the U.S. They could trade their dollars for some other currency, and people in that other nation would go through the same decision process. It really doesn't matter. Those dollars eventually get back to the U.S.

Why do you believe it is stupid for people to become indebted? And what does that have to do with the current account deficit anyway? Imports have reduced sharply the prices of almost every good we buy. Lower prices allow people to buy goods without incurring debt.

Posted by: John Dewey | Nov 15, 2007 8:11:01 AM

John,

"I'm not sure what you mean. Are you referring to percentage growth?"

Sorry - yes I meant percentage growth. If this is the correct data to be considering, it seems to me that if someone was to assert a growing trade deficit that grew to some limit (say inifinity) was a good idea, they would want to be seeing net worth growing percentage wise faster than liabilities because otherwise in the very looooong run it would be a bad idea. Of course economic contractions would in practice likely reverse the trend so there may be no long run effect.

Posted by: Mark Seery | Nov 15, 2007 10:13:11 AM

They COULD. They DID NOT. That is the reason why the US have the deficit. If they DID buy other currencies, the dollar would depreciate. If they bought the goods, it would precipitate huge inflation in the US. When the dollars get eventually back to the US, it will be a disaster (runaway inflation, depreciation etc.).

Why do I find it stupid for people to get into debt for consumption? Because the debts must be paid. Which means that unless you expect magical raise in your productivity, you will have to reduce your consumption in the future. You became very vulnerable to swings in the economy, unable to adjust your time in the future etc.

Yes, the USA has very cheap imports. The reason is China giving you a discount. That would be great and fine if you were on a commodity monetary system with no government debts. Unfortunately, when using fiat currency the discount is not without strings attached...

Posted by: andy | Nov 15, 2007 10:37:23 AM

Mark Seery,

I'm not sure I understand about the bad idea part.

Consider this extreme case:
- net worth of U.S. households does not grow;
- foreign corporations continue to create capitalk assets in the U.S.;
- foreign investors continue to buy U.S. equities;
- foreign central banks continue to purchase some of the U.S. government securities.

Where is the harm to the U.S.?

Should we care that foreigners own an increasing share of U.S. equities?

Should we care that new auto plants - built in the U.S. and employing U.S. workers - are owned by Honda and Toyota rather than GM and Ford?

Given that our federal government spends more than it takes in, should we care that foreign governments rather than U.S. citizens purchase U.S. government securities?

Of course, net worth of U.S. households is increasing. In absolute dollars, that net worth is increasing much more than the current account deficit ($4 trillion vs $800 billion per year). So we are not selling off ownership of the U.S. Rather, we are increasing enormously the wealth in the U.S., with a small portion of that increased wealth going to foreigners.

Posted by: John Dewey | Nov 15, 2007 10:59:59 AM

Andy,

You are confusing me. Are you saying that it is stupid for households to be indebted? Or is it government spending more than it takes in that bothers you so much?

I've been in debt for almost all my adult life. I've borrowed for my education and for my housing. Yet my net worth has increased tremendously over those 35 adult years.

Businesses borrow money all the time in order to take advantage of opportunities. Successful businesses do not reduce their consumption because of that debt. They employ leverage to increase returns to the business owners.

Indebtedness is not a bad thing.

Posted by: John Dewey | Nov 15, 2007 11:10:28 AM

Andy: "If they bought the goods, it would precipitate huge inflation in the US. When the dollars get eventually back to the US, it will be a disaster (runaway inflation, depreciation etc.). "

Andy, I think those dollars got back to the U.S. the minute the Chinese bought U.S. government securities. The U.S government then immediately spent them.

Posted by: John Dewey | Nov 15, 2007 11:54:41 AM

I have specifically stated that going in debt for consumption is a bad thing. I did not comment on such things as education or company debt as this is generally a way to invest (although I think a healthy company should be able to work without debt anyway - the leverage seems to me mainly the result of tax law).

Andy, I think those dollars got back to the U.S. the minute the Chinese bought U.S. government securities. The U.S government then immediately spent them.

Actually...this is interesting question, and while searching on the internet I found this: http://www.buoyanteconomies.com/USACAD.htm ... well, it's not going to be that simple after all :)

Posted by: andy | Nov 15, 2007 12:58:46 PM

Andy: "I have specifically stated that going in debt for consumption is a bad thing. I did not comment on such things as education or company debt as this is generally a way to invest."

Pardon me, then. You did say consumption.

I think education spending is considered consumption by economists.

In addition to education, purchases of housing, automobiles, appliances, and furniture are commonly made with debt. Having made numerous such purchases myself over thirty-five years, I guess I cannot understand what is stupid about doing so.

Posted by: John Dewey | Nov 15, 2007 3:04:00 PM

Hi John,

There is a significant amount of sophistication above when compared to the general kind of dialog I here among lay people. Lay people have an emotional reaction to the notion that one day we may have more liabilities than net worth, which is the obvious conclusion of trends: if liabilities grow 2% per year more than net worth then the cross over would be 80 years, 3% then 53 years, 4% then 40 years, 5% then 32 years, etc.....of course anything above 3% is higher than current trends, but just to make a point.....

As you say, this should be explainable in very personal terms. If I take a mortgage to buy a house, if I have enough cash flow to cover the debt obligation, and if the appreciation on the house is more than servicing the debt+inflation (and perhaps even some consideration for the time value of money) then I am ahead. Assuming the assets I hold (the house) never get revalued, then this in general is an example of how investment can lead to accumulation of wealth. So I don't disagree with you on your assertion on that count, assuming we both have the same assumptions. Though I will note, you rarely here this kind of discourse among the general public/reporting.

The challenge then is to find a way to articulate the case that having a decreasing ratio of net worth over liabilities is not a problem. I suspect this is unintuitive because most people plan in to retirement with a view that their net worth / liabilities ratio will be increasing, but of course an economy does not retire ;-)

But just to wrap up, if for the sake of argument the liabilities of the U.S. were today 4x or 10x the net worth, and the difference was growing, would that cause you no concern?

Posted by: Mark Seery | Nov 15, 2007 4:05:36 PM

Mark Seery: "if for the sake of argument the liabilities of the U.S. were today 4x or 10x the net worth, and the difference was growing, would that cause you no concern?"

I really cannot conceive of that happening, but maybe it would concern me.

Consider looking not at percentage growth but at absolute growth in liabilities versus net worth. The growth in net worth has recently been four times the growth in liabilities. As long as the former absolute growth exceeds the latter, the scenario you described won't happen.

I'm just suggesting that projecting percentage growth rates into the future could be misleading. Perhaps we need to look at more than five years of data.

In any case, thanks for the discussion. I've enjoyed considering your suggestions.

Posted by: John Dewey | Nov 15, 2007 5:26:03 PM

Regarding the deficit - I have looked into their paper and they seem to link the deficit not to the growth, but rather to money supply and on the willingnes of investors to speculate on higher value of money then would be wise. Well... the money supply and growth are somewhat interconnected in current monetary system, so it is somewhat dubious what is the cause and what is the consequence - if you have 2 countries trading, the one that prints more money will have deficit.. that seems to be a precursor to inflation...

As for the debt: I would consider education an investment (if you are going to use what you have learned, it does meet the investment definition), the car may be an investment. The rest is consumption. The fact is that our grandparents could buy these things without becoming indebted. Current fractional banking system allows lending more money at lower interest rates. Some people use it and this makes all these things more expensive for those who do not want to live in debt.

Everybody can make a choice - but current system discourages living without debt. And this leads to many problems, e.g. when the interest rates raise (which is probably going to come when China dumps the bonds).It is very unstable and risky when most of the people do not follow sound 'family fiscal policy'.

Posted by: andy | Nov 15, 2007 6:03:54 PM

I am coming back to this discussion a little bit late. I think that the best way to look at the international trade and capital account balances is that they are a result of what is happening in the real U.S. economy as compared to the rest of the world rather than a cause of what is happening.
I want the U.S. government to pursue policies that result in a strong and stable U.S economy because this effects my earnings most directly. So I would prefer that the U.S. government not incur large deficts. I would prefer that the deficit be reduced by controlling spending rather than raising taxes. I would prefer that the U.S. government pursue a stable, non-inflationary monetary policy. I would prefer that the government allow the private sector to control most of the economy, except to the extent it needs to provide public goods, such as national defense. I would prefer that the government not regulate the private sector except to the extent necessary to correct market failures. I would prefer that the government not create barriers to free international trade.
If the U.S. government pursues policies such as these that encourage the strong growth of the United States economy, then I don't care much about the international markets because they will move in reaction to a strong U.S. economy. If other countries choose polcies that manipulate the terms of trade, that hurts their citizens, not ours.
So long as the U.S. is growing as a result of good government policy, I don't care much whether the dollar is strong or weak or whether we are running a trade surplus or deficit.

Posted by: pauld | Nov 16, 2007 1:14:04 PM

A thousand words, eh? Oughtn't a picture have sufficed?

Posted by: Russell Nelson | Nov 17, 2007 10:02:25 PM

Chris, consider that I could sell a foreigner shoes, or I could create a franchise business that sells shoes, .... and I could sell the foreigner *that*. When economic growth is high, our trading partners are happy to buy our businesses.

Posted by: Russell Nelson | Nov 17, 2007 10:07:34 PM

I think I successfully explained why we trade in exactly 21 words, approximately 50 times more efficiently than our host.

Posted by: Russell Nelson | Nov 17, 2007 10:12:29 PM

As a student of these things, i have a question.. ( i should also confess i only skimmed through the previous discussion)

From a developing countries stand point, it seems to me, the rejuvenated mercantilist ideology in the form of Economic nationalism, etc. Doesn't really advocate a total ban on imports, in fact they welcome imports so long as an equivalent is not produced locally or not adequate (mostly in terms of volume) for domestic consumption.

there argument seems to be that we should export more than we import and use the excess money to consume local products so that local industries get a chance to develop..

what would be your response to this argument?

Posted by: Deane | Nov 20, 2007 1:37:31 AM

Deane: "they welcome imports so long as an equivalent is not produced locally or not adequate (mostly in terms of volume) for domestic consumption."

And that is their mistake. If workers in another nation can provide a good at a lower price, why should a government deny its citizens the right to purchase that good at a lower price?

If the government gets out of the way, local business will develop just fine. Even if the absolute advantage falls to the richer nation, the poor nation may still realize a comparative advantage that will allow its workers to produce a good for trade.

Comparative advantage and free trade will work together to allow everyone to imcrease their standard of living. The chief role of government with respect to trade should be to enable property rights. That's where many governments fail, of course.

Posted by: John Dewey | Nov 21, 2007 8:29:16 AM

Sometimes this entire argument seems really misguided.

When a single business imports more than it exports, we call this "profit" and are of the general understanding that it is a Good Thing.

So when the entire nation imports more than it exports, isn't that just the same Good Thing on a national scale? Doesn't it naturally imply that the average business necessarily imports more than it exports?

What's to argue?

Posted by: Caliban Darklock | Nov 26, 2007 11:01:22 AM

Not sure if i follow you Caliban.. but i think most people interpret the country as a business, exports are revenues (money comes in) and imports are costs(money goes out) . i do realise the error.. but dont quite follow you on the argument..

John, i understand. but generally people (at least here, in the developing world) is collectivist enough that ask others to forgo this so that the local industries can develop.

i suppose this is the old, infant industry argument.. but i get your point thanks..

Posted by: Deane | Nov 26, 2007 3:22:29 PM

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