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Free Trade Brings More Foreign Investment into the US. That's a Good Thing.

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Tags Free MarketsProtectionism and Free Trade

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When politicians and pundits tackle international trade matters, discussions inevitably end up focusing on whether Americans get the short end of the stick when they trade with foreigners. The consensus among these folks is that they do. The evidence: Americans buy more goods and services from foreigners than they sell to them.

That this buy and sell ledger might trace normal market forces and actually describe something favorable about the US economy is never considered. Instead, the shortfall is attributed to clandestine policy interventions by foreign governments that tilt the international economic playing field in foreigners’ favor.

The problem here is that the politicians and pundits have a blind spot when it comes to international economic transactions. They ignore a portion of trade! In particular, they ignore trade in claims on future income—that is, stocks and bonds. When this latter trade is included in the discussion, all bets are off when it comes to the short end of the stick contention. Indeed, Americans buying more goods and services from foreigners than foreigners buy from Americans can be the result of American economic success. Ignoring or excluding relevant information makes a difference—a big difference!

Dollars and Foreign Currencies

When foreigners sell things to Americans, foreigners want to be paid in their currency. Americans are no different. They want to be paid in dollars for what they sell to foreigners. The result? Markets in currencies exist. Foreigners buy dollars with their currencies. Americans buy foreign currencies with dollars. In other words, foreigners demand dollars and supply their own currencies. Americans demand foreign currencies and supply dollars.

As with any other market, prices of currencies will gravitate toward where the quantity of dollars demanded by foreigners equals the quantity of dollars supplied by Americans. Ditto for the quantities of foreign currencies demanded and supplied.

Telling the Whole Story

So it follows that the price of the dollar will gravitate toward where the quantity of dollars demanded and supplied for trade in current goods and services and for claims on future goods and services will be the same. There is no reason that each component of the quantity of dollars demanded must equal its supplied counterpart. None whatsoever.

Suppose that relative to the rest of the world the United States is a better place to hold wealth. Reasons might be 1) property rights are more secure, 2) there are fewer exceptions to the rule of law, 3) tax rates are lower, and/or 4) safety against foreign aggression is much greater. Such factors will lead wealth holders (including those in the United States) to desire to hold a disproportionate share of their wealth—existing wealth as well as additions to it—in the United States.

In other words, foreigners will be demanding more dollars to buy US stocks and bonds compared to what Americans are supplying to buy foreign stocks and bonds. It necessarily follows that the equilibrium price of the dollar will be such that Americans buy more goods and services from foreigners than they buy from Americans by an amount that offsets the US trade surplus in stocks and bonds. Otherwise, the market in dollars will not clear.

Nothing could be further from the truth than to conclude that the US deficit in current goods and services means that Americans get the short end of the stick. Indeed, the truth is quite the opposite. Americans have a successful economy, so successful, in fact, that foreigners want to buy their way into it. What’s wrong with that?

Given this, any pundit or politician’s policy proposal to get rid of this deficit must undermine the ingredients of US success. For example, make property rights less secure. That will do it, and then Americans will get a stick that’s actually shorter, not one that is the result of pundit and politician blind spots.

Further Thoughts

Notwithstanding the above, I submit that there is an additional factor explaining the short end of the stick assertion. Namely that exports are widely regarded as intrinsically “good,” just as imports are seen as intrinsically “bad.” Who hasn’t heard that exports “create jobs” and imports “destroy jobs.” Likewise for imports being “dumped” on Americans? Or imports being likened to “invading foreign armies”? Or imports being traced to “tilted economic playing fields”?

Unable or unwilling to incorporate the implications of trade in stocks and bonds into their thinking, pundits and politicians fall back on these decidedly negative characterizations of imports: if there is a deficit in US trade in current goods and services, then the “bad” coming in exceeds the”good” going out. Translation: Americans are getting the short end of the stick.

The irony here is that none of the pundits and politicians organize their households based on this mindset. Pundits’ and politicians’ incomes measure the value of what they export to their fellow citizens. It is these exports which enable pundits and politicians to import housing, food, clothing, etc. Take away these imports, and our pundits and politicians would be ill housed, ill fed, ill clothed, if not dead. That is, pundits and politicians export in order to import when it comes to their own affairs. Yet they ask the opposite of the national household. Alas.

Author:

Contact T. Norman Van Cott

T. Norman Van Cott, an adjunct scholar with the Indiana Policy Review Foundation, is professor of economics at Ball State University, Muncie, IN.

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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