Jun 15

I feel slighted.  For years I’ve been going to my dentist, and not once has he come over to my house to buy anything.   Likewise, my supermarket has never offered to purchase produce from my backyard garden.   And the mechanic at the place where I get my car repaired has never had me repair one of his on my driveway.

I think I’m running a “trade deficit” with each of them.   At least that’s what I’m led to believe by listening to people who claim we have large trade deficits with certain countries, like China.

“You nimwit!”, says the ghost of my tenth grade accounting teacher.  “You’ve forgotten your T-Accounts!  All year long we drew those things on the board, and this is the thanks I get?!”

Oh, yeah, the T-Accounts…   What would the T-Accounts say about my “trade” with my dentist?

In my “services received (expensed)” account, I’d place a debit for say, $100.  I’d have an offsetting $100 credit to my cash account.    I’m in balance with myself.  Likewise, my dentist would credit his “services rendered” account for $100 and debit his cash account for $100.   He’s in balance.  In simple terms, I got a checkup from the dentist, and he got $100 from me.    We’re in balance with each other.  If we weren’t, he’d either sick a collection agency on me, or I’d tell all of my friends not to visit his practice.

Yet the chorus of people who believe we have a trade deficit with China, or elsewhere, see things differently, by attempting to perform an economic sleight-of-hand:  They aggregate the goods and services that exchange hands between trading partners, yet ignore the cash.   Worse still, they attempt to substitute other debts and deficits into the conversation, such as our operating budget deficit, as if they are all one in the same.    It often goes something like this:  “Our international trade deficit in April was $40 billion, and we’re borrowing all sorts of money from China to pay for it!”

None of this would matter, if their wished-for remedies weren’t so potentially harmful.

Remember that money and credit came along simply because bartering for stuff can get physically difficult.   I mean, if I want to exchange my corn for your wheat, on a small scale, we could probably work something out.   But if I’m in the market for your wheat, and all I have to trade are bricks, and your new brick house doesn’t need another floor or a new chimney, I’m out of luck.   However, if we can agree that some piece of paper can act as a stand-in for the wheat and the bricks, it can become a kind of Rosetta Stone for us, allowing us to translate each other’s language into something common.

So in the aggregate, when one totals up the value of all the stuff that we’ve purchased from China, and compares it to what they’ve purchased from us, and one finds that we have a deficit of “stuff sold”, remember the dentist:  Every transaction was balanced with paper.

“I guess that must mean that we have a lot of their stuff, and they have a lot of our paper.”

Exactly.

Now the only reason they’d be willing to take paper with dead presidents on it in exchange for their stuff, is that they believe the paper is worth something, that it can be converted to other stuff somewhere down the road.  And in fact, considering the paper itself isn’t too useful (it’s small, you can’t write much on it, wallpapering with it would be tedious, etc.), if we ever want to buy anything again from them with our paper, we have every incentive to make sure it’s worth something, which is a good check on what might otherwise be even more profligate tendencies.   Furthermore, one could say that the paper they now hold from us represents future spending somewhere else, back in our country if the value proposition is good for them, or elsewhere.

And therein lies the reason we buy a lot of stuff from China:  the value proposition is good for us. Indeed, amidst all of the creeping tax increases and inflationary pressures within our society, low prices on goods from China and elsewhere help to keep things affordable.

“All fine and good, but you sound like a free-trader, and China doesn’t practice free trade.”

In many respects, that’s probably true.   But what should we do instead?   Should we limit the amount of imports we take in from China?    Should we force people to use their second or third-choice supplier because they are within our borders?  Most importantly, if we go down those roads, who will decide how such a system will run, and manage the consequences?  Who will explain to the WalMart shopper why their sales receipt is now significantly larger?    Wherever we do this type of thing already, (like our crazy sugar tariffs), the first people we hurt are our own citizens.

Perhaps it would be more instructive to examine why we need China to create a value proposition for us. What is it about our society that causes it to be un-economic for so many products to be manufactured here?   Why is our economic soil becoming steadily less fertile?   Rather than mandate that things purchased here must be manufactured here, perhaps we should ask manufacturers why they’re considering leaving.   Perhaps we should be figuring out ways to entice them to stay.   The Berlin Wall was built for a reason, and something tells me the typical North Korean citizen doesn’t relish their own version.

Last time I checked, I wasn’t personally borrowing any money from China to finance my own spending.  But the federal government borrows tons of money, via Federal Reserve auctions, to pay for things that voters demand.  Now although I vote, yet if given a choice would vote for a balanced budget, must I, too, be included in that group of demanders? In 2009, our “trade deficit” was nearly $380 billion.  But our operating budget deficit, representing our government’s non-borrowing revenue sources minus the cost of all of the things that we ask it to do, was over $1 trillion more than that (approximately $1.4 trillion in total).   So when Warren Buffet or others talk about China buying up our bonds so we can finance our trade deficit, is that really what’s going on?  If our private sector exported more to China, and imported less, would those changes finance runaway entitlement programs like Social Security, Medicare or Obamacare?

Maybe rather than concocting elaborate schemes to manage our global trade, if we’re concerned with debt (and we should be), perhaps we should start by getting our internal affairs in order, over which we have complete control.   At the same time, we can quit fretting about the economic preferences of other governments, control over which we have next to none.

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6 Responses to “The Illusion of Trade Deficits”

  1. David Hoyt says:

    Great analysis! It reminds me of a quote my father taught me a long time ago. Two economists were talking about ‘trade deficits’ and one reminded the other what Abe Lincoln said on the subject: “all I know is, if I buy a hat for $10 in America, that $10 stays in America.” To which the second economist said, “he’s right that is all he knows.” Ha!

  2. David Hoyt says:

    Great analysis!

  3. MichaelS says:

    One more thing. We “ignore the cash” because the balance of payments (i.e. net changes in cash holdings) is effectively zero and has been since we went off Bretton Woods. The Current Account (Trade Deficit) is offset by the Capital Account (increases in net foreign holdings of U.S. debt). So, yes, I do have an idea of what I am talking about,

  4. MichaelS says:

    Now although I vote, yet if given a choice would vote for a balanced budget, must I, too, be included in that group of demanders?

    No you wouldn’t, so yes you must. Right now, the deficit is more than Social security, Medicare, and Obamacare combined (assuming we eliminated these programs, but kept the taxes associated with them) and presumably you aren’t advocating ending the billions in wars your friends in the Republican party started. Pork is a rounding error in the budget. Passing a balanced budget now would require billions in tax hikes and send us into a second great depression.

    So when Warren Buffet or others talk about China buying up our bonds so we can finance our trade deficit, is that really what’s going on?

    Uhh, yes? We aren’t forcing China to buy up our debt; it’s buying it up of its own accord. Countries around the world are buying our government largesse at the expense of American workers, because if they actually did go back to work, they’d compete with Chinese workers (I’m not sure they’ve thought it out that way, but that is the effect of what they’re doing). They hope that the government continues to run huge deficits and keep THEIR economy growing. With them bidding our interest rate all the way down to zero, our government is left with no choice but to run deficits to try to stabilize our economy. Without those deficits, unemployment would be even higher.

    If we could limit the buying of American bonds (and Warren Buffett’s idea would have that effect). Then the Fed wouldn’t have shot through its ammo so quickly, and interest rates would be low, but not anywhere close to zero. We could shrink the government and balance the budget without hurting the broader American economy, because the fed could respond to our austerity measures by keeping interest rates low (as they did in the 90s).

    In summary, your free trade dogma is exactly what is feeding the government you claim to despise. A more sensible trade policy that focused on consumption and production in equal measure while maintaining the freedom to trade individual goods and services is what is needed if we are to get out of this mess. There’s no point asking our seniors to work longer, or our poor to work for health care, or our unemployed to find a job if people in China are taking all the work. To hell with the sugar tarriffs; I don’t care what we produce. Just produce something.

  5. Debbie D. says:

    Excellent essay. As usual, most people rely on catch phrases from the media instead of reasoning. I’m going to send this off to all of my friends who are in a panic over China. Thanks!

  6. DD says:

    Unless it is life or death necessary, don’t buy your toaster or other goods from China and there won’t be a problem. Buy USA or don’t buy at all. Soon, someone will build a toaster made in USA.

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