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Deficits Don't Matter?

12/29/2005

Thosten Polleit wrote recently for Mises.org against the neccesity of US trade surpluses reversing accompanied by a decline in the dollar:

As long as the United States is perceived by investors as providing the market place with institutions that are conducive to free market economies and which generate favorable growth and capital return rates (compared to Europe and Japan for example), the United States will maintain its position as a favored investment region. As a result, the United States is likely to remain in a position to accumulate capital account surpluses, with the external value of the greenback remaining under appreciating pressure.

In a somewhat similar vein, Louis Vincent Gave (speaking on Financial Sense News Hour about his new book) that the US economy should be likened to a large hedge fund that takes in capital from all over the world because it can allocate resources more effectively to their highest-valued use and can specialize in high-margin activities like product design while outsource low-value added manufacturing.

Frequent Mises.org contributor Dr. Antony Müller writes in The US Trade Deficit: to worry or not to worry? that it is not market forces at all that are driving the trade deficit. It should not be looked upon as the outcome of rational allocation of resources:

What's behind the massive capital flows to the United States is not capitalist calculation, but the role of foreign central banks, which are held to slow down the appreciation of their own currencies against the US dollar. The repressed adaptation of the exchange rates favors the export industries these countries. The US manufacturing industry is shrinking, while that of the trade surplus countries is expanding.

and

Domestically, the US trade deficit has insufficient national savings at its root. That, in turn, is the result of two other factors: Low private savings result from high consumption relative to income; and the negative public savings are the consequence of high government expenditures relative to government income.

Trade deficits don't matter as long as that there is someone who finances the debtor. The looming problem, however, is the impact that these financial flows have on the capital structures of the economies involved. Persistent imbalances bring about changes in the composition of a country's production structure. Depending on the duration and size of the imbalance, profound transformations of the capital structures occur. The economy of the country with the trade deficit is losing its manufacturing base while the country with the export surplus is overextending its manufacturing industries. This, in itself would not be a problem if the deficits were sustainable; but when the trade deficit comes along with debt accumulation, there is a limit to this process.

The present circumstances are not sustainable and can go on only until the interest on the debt compounds to the point that debt service payments overwhelm the ability of the surplus country to sell more goods. At that point, a rapid readjustment must occur.

Another Mises.org contributor, Chris Mayer, is part of a panel discussion on this topic reported in today's Rude Awakening letter. Panelist Justice Little states

But when much of the world's capital is being parked in US Treasuries rather than wealth-building entities, and when we are spending like mad at home on flat-screen TVs and I-pods, and US stocks have dangerous valuations and entitlement programs are looming large, it is hard to be sanguine about the deficit. In this case, the capitalaccount surplus looks more like a bulge of borrowed money,parked in Treasuries that could be quickly 'unparked' at any given time.

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