On Free Trade 3: Exports Sucking Out American Money
By Rick Kelo
By Rick Kelo
TRADE DEFICITS... UH OH
A nation pays for its imports with its exports. So what happens when a country (like the US) imports more than it exports. This is a trade deficit. In the 1600s mankind adopted a school of thought called Mercantilism. Mercantilism stated that trade surpluses were good and trade deficits were bad. Even though mercantilism was refuted around the 1800s this myth has existed in the collective consciousness of many who are still led to believe a trade deficit is bad. What a trade deficit really means is that our nation is exporting money in return for foreign imports instead of exporting only goods in return for foreign goods.
An example:
Picture a lawyer who lives in downtown New York City. He eats out every day at the restaurants nearby. Breakfast, lunch and dinner. Last year no owner or worker from any of the restaurants hired him to represent them. He is running a trade deficit with his favorite restaurants: he is spending more money on the things they produce than they are spending on the things he produces. Is this a recipe for the lawyer's economic collapse?! Of course it isn't.
Somehow this exact scenario above becomes hard to picture when we are asked to picture a nation instead of our individual lawyer. By the way, why isn't this lawyer's trade deficit with his trade partners a problem? The restaurant isn't the only group the lawyer trades with in a year. He happens to run a pretty big trade surplus with the law firm who employs him.
What if the lawyer was in a total trade deficit though? If the restaurants were willing to give the lawyer food every day and expect no payment then he has gotten a very good deal. Likewise if other countries in the world were stupid enough to send us awesome goods that we desire in return for nothing but $100 bills that would be a great deal. Here's an easy explanation in the video below:
HOW TRADE DEFICITS WORK
Like we mentioned the idea of the trade deficit goes back to the mercantalists who felt the need to stockpile as much money as possible. In the 1600s they were trading the goods their country made (its economic output) for money. Except "money" in those days wasn't green pieces of paper, it was pieces of gold. So, in effect, the Mercantalists were trading goods from their country (say cars & Florida oranges) for gold (also a good produced through mining output in another country).
Like we mentioned the idea of the trade deficit goes back to the mercantalists who felt the need to stockpile as much money as possible. In the 1600s they were trading the goods their country made (its economic output) for money. Except "money" in those days wasn't green pieces of paper, it was pieces of gold. So, in effect, the Mercantalists were trading goods from their country (say cars & Florida oranges) for gold (also a good produced through mining output in another country).
What happened?
Well as one country ran a trade surplus more gold ended up in that country. As we now know gold is a commodity. What happens to commodities when the supply goes up? Bingo.... price falls. So as one mercantalist nation would amass a greater amount of gold from a trade surplus the price of that gold fell. Since money was linked to a gold standard that decline in the value of gold made prices in the nation with the trade surplus rise and prices in the nation with the trade deficit fall. Eventually the citizens of the nation with the trade surplus (and the big gold stockpile) started buying the cheaper foreign goods and gold flowed out of their country.
That, ladies & gentlemen, is how economic equilibrium works. The only people willing to ignore this truth are usually special interest groups lobbying for a special government protection to their small group. They would prefer the federal government interfere with the voluntary spending decisions of American consumers as a special favor to them, while disguising their concern as the lowering of a trade deficit.
AN EXAMPLE: ASIAN TRADEThe Japanese export a lot of cars to America. Japan also imports things from America. In fact 80% of its oil is imported from America. Now suppose America reverts to Mercantalist thinking, gets concerned with our trade deficits, and decides to reduce them. It is decided we will artificially lower the amount of Japanese cars we bring into the nation. Government will either restrict them directly by force through an import quota or indirectly by forcing prices artificially higher through a tariff. In doing this the first order effect is American car sales must necessarily increase to make up the shortage in demand. The second order effect though is that we have reduced how much oil Japan can buy from workers in Texas & Alaska.
Lastly, let me close by point out that it is a total myth that trade deficits are caused by foreign competition. They're not. A trade deficit is only caused by American consumers. American consumers preferred to buy more goods from overseas than the amount of goods those same Americans produced, then decided to sell overseas.
TRADE DEFICITS AND JOBS
I'm going to close on this idea to shift us to tomorrow's article on outsourcing of jobs. One of the common, but incorrect, claims about trade deficits is that reducing them will create jobs in America. That is untrue because the trade deficit is precisely offset by another item called the "capital account surplus." Explained simply when US investors invest capital in a foreign country, then that dollar value of capital flows out of the US.
I'm going to close on this idea to shift us to tomorrow's article on outsourcing of jobs. One of the common, but incorrect, claims about trade deficits is that reducing them will create jobs in America. That is untrue because the trade deficit is precisely offset by another item called the "capital account surplus." Explained simply when US investors invest capital in a foreign country, then that dollar value of capital flows out of the US.
Now hold that thought in the back of your mind and think about the trade deficit. A trade deficit means that the dollar value of imports has been more than the dollar value of America's exports. Foreign capital has flowed into the US. The trade deficit is offset by these capital inflows as foreign investors have, in effect, built factories & businesses in the US. The only way to eliminate the $540B trade deficit America had last year is to also eliminate a $540B foreign investment surplus that creates American jobs.
People who discuss the impact of trade on outsourcing claim jobs are being exported, but they're not. The jobs that get outsourced move because foreigners have a comparative advantage over Americans in that industry. That kind of outsourcing is clearly good for America because it has the effect of the American consumer getting to hire cheap foreign labor and collect up the gains from trade.