The Nonproblem of the Trade Deficit
The Wall Street Journal reports today that the US trade gap shrunk during the first two months of this year.
Matt Drudge presented this report as evidence that the United States is "great again" with the headline in the usual Drudge fashion announcing "GREAT AGAIN: Trade Gap Shrinks as Exports Rise."
The problem with this assertion is that the so-called trade gap is not simply a measure of how much US firms export to other countries. It's a measure of relative consumption and foreign investment in the United States. So, if if increasing exports were evidence of the US being "great again" a decline in the trade deficit proves no such thing.
As Reuters reports, a factor in the shrinking trade gap is the fact that "slowing domestic demand weighed on imports." In other words, Americans apparently had less money to spend on goods and services imported from other countries.
Did Americans just decide to spend more money on domestic goods instead of foreign goods? It's possible. But the more likely explanation is that Americans simply had less money to spend. This is hardly evidence of anything being "great again."
Moreover, the shrinking deficit was also driven by rising foreign demand for American imports. Tim Worstall at Forbes explains:
The trade deficit closed because foreign countries are growing nicely and sucking in American imports. The American economy is growing more slowly meaning Americans desire fewer imports. People generally say that the trade deficit is a bad thing. But here it is shrinking because foreign economies are growing faster than the American. That's a good thing is it?
Moreover, a shrinking trade deficit also suggests a relative decline in foreign investment in the United States. Are we to believe that declining investment is also something to be happy about? Murray Rothbard notes:
The alleged "deficit" was paid for by foreigners investing the equivalent amount of money in American dollars: in real estate, capital goods, US securities, and bank accounts.
In effect, in the last couple of years, foreigners have been investing enough of their own funds in dollars to keep the dollar high, enabling us to purchase cheap imports. Instead of worrying and complaining about this development, we should rejoice that foreign investors are willing to finance our cheap imports.
Hans Sennholz concurred:
In recent years foreigners have made heavy investments not only in the booming stock market but also in American obligations, especially U.S. Treasury notes and bonds. In a world-wide process of economic globalization they have acquired control over numerous American corporations and bought some real estate. They are attracted not only by the ready availability of dollar funds in international money markets but also by the relatively high rates of American productivity, by high rates of interest and low rates of inflation. Their investments in American funds and facilities lend support to the dollar and finance the trade deficits. [Emphasis added.]
Rothbard and Sennholz wrote these words long ago, but the same is true today. Except in the most recent report, it seems that relatively tepid interest in investing in the United States is helping to reverse the process and bring the trade deficit down. Again, this is nothing to throw a party about.
RELATED: "Perpetual Trade Deficits Can Be Good" by Robert Murphy
Of course, this doesn't mean the status quo is all good news either. The continued trade deficits are only partly due to American productivity and foreign desires to invest in what is seen as a relatively strong economy. The trade deficit is also made possible by continued foreign interest in holding dollars. This is not based on the dollar's strength so much as it's based on the relative weakness of other currencies — such as the euro — since central banks worldwide appear to be engaged in a race to the bottom. The US dollar looks good by comparison, but if the day ever comes that foreigners stop viewing the dollar as an especially valuable reserve currency, the US will be in for a rude awakening.
Finally, it's worth noting that Murray Rothbard referred to the trade deficit as a "psuedoproblem created by the existence of customs statistics" and that "in the fiat-money era, balance-of-payments deficits are truly meaningless":
A final set of arguments, or rather alarms, center on the mysteries of the balance of payments. Protectionists focus on the horrors of imports being greater than exports, implying that if market forces continued unchecked, Americans might wind up buying everything from abroad, while selling foreigners nothing, so that American consumers will have engorged themselves to the permanent ruin of American business firms. But if the exports really fell to somewhere near zero, where in the world would Americans still find the money to purchase foreign products? The balance of payments, as we said earlier, is a pseudoproblem created by the existence of customs statistics.
During the day of the gold standard, a deficit in the national balance of payments was a problem, but only because of the nature of the fractional-reserve banking system. If US banks, spurred on by the Fed or previous forms of central banks, inflated money and credit, the American inflation would lead to higher prices in the United States, and this would discourage exports and encourage imports. The resulting deficit had to be paid for in some way, and during the gold-standard era this meant being paid for in gold, the international money. So as bank credit expanded, gold began to flow out of the country, which put the fractional-reserve banks in even shakier shape. To meet the threat to their solvency posed by the gold outflow, the banks eventually were forced to contract credit, precipitating a recession and reversing the balance-of-payment deficits, thus bringing gold back into the country.
But now, in the fiat-money era, balance-of-payments deficits are truly meaningless. For gold is no longer a "balancing item." In effect, there is no deficit in the balance of payments. It is true that in the last few years, imports have been greater than exports by $150 billion or so per year. But no gold flowed out of the country. Neither did dollars "leak" out...
We conclude that the sheaf of protectionist arguments, many plausible at first glance, are really a tissue of egregious fallacies. They betray a complete ignorance of the most basic economic analysis. Indeed, some of the arguments are almost embarrassing replicas of the most ridiculous claims of 17th-century mercantilism: for example, that it is somehow a calamitous problem that the United States has a balance-of-trade deficit, not overall, but merely with one specific country, e.g., Japan.
Must we even relearn the rebuttals of the more sophisticated mercantilists of the 18th century — namely, that balances with individual countries will cancel each other out, and therefore that we should only concern ourselves with the overall balance? (Let alone realize that the overall balance is no problem either.) But we need not reread the economic literature to realize that the impetus for protectionism comes not from preposterous theories, but from the quest for coerced special privilege and restraint of trade at the expense of efficient competitors and consumers.
In the host of special interests using the political process to repress and loot the rest of us, the protectionists are among the most venerable. It is high time that we get them, once and for all, off our backs, and treat them with the righteous indignation they so richly deserve.