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Tom Rexton

The soaring trade deficit

2 posts in this topic

Mr. Salsman,

I'd like to ask two questions, which I think are related:

1. Economists world wide are worried about the "unsustainble", ever-expanding US current acount deficit. Is their anxiety justified? It seems contradictory to me: how can the large current acount deficit be harmful if it results in a net gain of goods and capital to Americans?

2. The national savings rate has decline dramatically over the past two decades and is now close to 0%. If I'm not mistaken, does that not imply that there will be insufficient capital necessary for sustained, long-term economic growth? (unless the savings rate is restored by severe market corrections)

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This is Richard Salsman's reply to the question posed by Tom Rexton.

You're perceptive in recognizing that these questions are related. Let's take the first one. Yes, most economists are anxious about the U.S. trade deficit and its alleged "unsustainability" - but for no good reason. Their fears are animated by mercantilism, a body of (so-called) thought smashed and refuted more than two centuries ago by Adam Smith, Jean-Baptiste Say and David Ricardo. Mercantilism was revived by John Maynard Keynes in the 1930s; it should be no surprise that mercantilism has made a comeback, for Keynes has dominated modern economics for most of the past seven decades.  Mercantilists hold that a nation prospers only if it imports more money than goods and services - and further claim that a nation's businesses and workers prosper only if they produce goods and services that are sent to others abroad. This rests on an absurd view of what constitutes wealth.

People should recognize that the concept of a "trade deficit" flows directly from an artificial, context-dropping calculation that's widely-promoted by mercantilists: they focus myopically on the total of a nation's merchandise exports and subtract the total of its merchandise imports over some period.  If imports exceed exports they call that a trade deficit; likewise, if exports exceed imports they call that a trade surplus. But they go still further - and insist that a trade deficit is somehow "bad" while a trade surplus is "good." Before examining this further, let's understand what, precisely, this mercantilist premise assumes: it assumes an inherent antagonism among nations worldwide, for it is impossible for ALL nations together to record trade surpluses, since surpluses are, necessarily, the mirror image of trade deficits; and it fallaciously assumes that trade entails a "zero-sum game" of "benefited" versus "harmed" nations.  Armed with such vicious premises, mercantilists over the centuries have caused wars.

At root mercantilism rests on nationalism; it desires a state that's all-powerful and wealth that's collectively owned. In rejecting this view, let's understand what's really going on today - by individualizing international trade. For international trade data are merely sum totals of individual trades.  Suppose you buy a Japanese car for $30,000 from a local car dealer; the dealer obviously obtained the car by paying money to the Japanese carmaker.  There is no "imbalance" to speak of, since the money trades for the car. There's an "imbalance" only if one chooses to split the transaction in two parts and claims there's a "problem" because you imported the good while the Japanese carmaker did not import a good from you.  Instead, he imported your money. To insist that goods trade against goods is effectively to wish for a barter economy - that is, a primitive economy devoid of money and credit.

Notice, by the way, that the mercantilists do not seem to obsess about the other half of the transaction; that is, they don't become anxious about the fact that the Japanese carmaker records a "financial deficit" - deriving from the fact that he imported cash from you while you "failed" to import cash from him. I hope you can glimpse how ridiculous it is to arbitrarily split such transactions - or millions of them - into two pieces, then to worry about some alleged "imbalance." The only "imbalance" I can observe is in the mercantilists' own context-dropping minds. You're right that there's nothing at all "unsustainable" about trade deficits, since each party gets what he wants, trade-by-trade, to mutual advantage. And I hope you also can surmise that even on an individual level - "at home" - you generate a "trade deficit" when, for example, you walk out of a grocery store after buying ("importing") a loaf of bread upon paying ("exporting") $2 worth of cash to the grocer. Is this transaction "unsustainable?" No, it isn't. Consider another example: New York City (allegedly) "suffers" from a massive trade deficit - in food. Why? It imports most of its food from outside of Manhattan and pays cash for it out of the proceeds from the goods and services it sells (advertising, financial and broadcasting services). Is New York City's "trade deficit" in food also "unsustainable?" Not in the least.  Finally, I hope you can recognize the absurdity in those economists who worry about the U.S. becoming a "debtor nation" or about how "we" are going to "finance" "our" burgeoning trade deficit - as if trade is a collective act or amounts to buying things without paying for them, or without contracting to pay for them over time (on credit). Let's also realize that a seller of goods extends credit (i.e., willingly accepts a bond, in return for the goods he sells) only because he has a rational expectation of eventually being paid on that bond.

Whereas a "nation's" trade deficit is its net imports of merchandise, its current account deficit is its net imports of merchandise plus services.  But the mirror-image of a nation's current account deficit is its net investment surplus; this category is an integral part of international accounting, but it is wholly (and conveniently) ignored by the mercantilist economists. A net investment surplus for the U.S. simply means that more investment is coming into the U.S. from abroad than is going out of the U.S.  to foreign nations. Let's return to the Japanese car-maker in my earlier example: he takes the cash that he has received from the sale of the car which he exported to you (via the car dealer) and buys either real estate or bonds or stocks in the U.S.  To that extent the U.S. records a net investment surplus - while Japan records a net investment deficit. Think of the U.S. current account deficit - the net imports of goods and services as paid for, at every instant in time, by America's net exports of titles to land or businesses (deeds, stocks and bonds). The two sums necessarily offset one another (balance), just as the $30,000 which you pay for the Japanese car is an "offset" to the $30,000 car you receive. Understanding this, you might also understand why the U.S. could run current account deficits indefinitely. The main result, over time, is that more and more "U.S.-based assets" would be owned by foreigners. But so what? Only a nationalistic nativist (Pat Buchanan?) worries about the alleged "selling of America" to allegedly untrustworthy and evil foreigners. Is an Ohio auto-worker harmed because the plant he works in is owned by Nissan, not GM?  Do you worry after you've booked a room in a hotel because you've learned that it's owned by a Canadian, not an American firm? Is it a problem if a German insurance firm - not Fidelity Investments in Boston - owns IBM shares or U.S. Treasury bonds? 

History shows that the U.S. trade deficit tends to expand whenever the U.S.  economy is growing more quickly than economies abroad; the U.S. thereby attracts imports at a faster pace than it generates exports, while slower-growing or stagnating economies abroad attract imports at a slower pace. If there is any "blame" to be assigned in this case, it should be assigned to those nations abroad whose governments so burden and penalize local producers that local economic growth rates are slower than in the U.S.  Significantly, in recent decades the U.S. trade deficit has narrowed - to mercantilist applause - only when the U.S. has been in recession, with a high and rising unemployment rate. This is what mercantilists demand when they demand that Washington "cure" the widening U.S. trade deficit. It's easy to narrow the trade deficit: one need only sabotage the U.S. economic growth rate.

It's true that Americans in aggregate also tend to run a current account deficit with the rest of the world because they save less than do people abroad - and that brings me to your related question about savings.  Eschewing nationalism, we need to think of international trade as we do domestic trade: we specialize, divide our labor and trade our productive surpluses with each other, to maximize and optimize the utility of our individual wealth mix. Just as some people are better at saving than are others, while others are better at coming up with new ideas and products than are others, so, in aggregate, some nations are better at saving than are other nations, while other nations are better at inventing investment opportunities than are other nations. In recent decades foreigners have generally saved more than Americans have, while Americans have generated more investment opportunities than foreigners have; thus America tends to attract more foreign investment versus the sums it invests abroad; as mentioned, this is the flip-side of America's trade deficit. Those who save trade their savings with those who provide investment vehicles; as in all trade, there is necessarily a balance. A net investment surplus - which the U.S. has been recording for most of the past three decades - is nothing other than a case of capital flowing into America and out of other nations (on a net basis).  But this is an international "vote of confidence" in the relative superiority of America's investment climate and property-rights system (bad as it is) Consider history, where socialist-fascists governments have so penalized success that they've suffered capital flight - that is, a severe, net investment deficit - a case of capital and investment fleeing an inhospitable nation for safer, more salutary nations. Since mercantilists despise the U.S. current account deficit and seek a current account surplus

- and a growing surplus, to boot - they effectively prefer that Americans suffer a massive capital flight, as socialist-fascist nations have suffered such flights historically. 

It's simply not true that (as you put it) "the national savings rate [for the U.S.] has decline dramatically over the past two decades and is now close to 0%." What you're probably referring to is the widely-reported rate at which U.S. households save out of their disposable (after-tax) income.  It's true that this rate has declined in recent decades and is now near zero. But the "national savings rate," technically speaking, includes these household savings plus 1) saving by business (out of retained earnings) and 2) saving by government (to the extent it runs a budget surplus). On average since the late 1950s U.S. business has saved roughly 50% of its after-tax income, a ratio that hasn't declined substantially; in the most recent year U.S. businesses saved $522 billion - or roughly 54% of their after-tax earnings. Whenever government runs a budget deficit - as it has for most of the past three decades (except during 1998-2000) - it does, of course, dissipate national savings and lower the national savings rate. As to the low household savings rate in the U.S., it's due entirely to the massive tax burden: Social Security taxes, income taxes, property taxes, sales taxes and taxes on income from interest, dividends and capital gains. Relative to governments abroad, the U.S. government (at all levels) taxes local, savings-based income far more punitively. This is another reason that savings from abroad flow into the U.S. Yet despite all the hand-wringing about the U.S. current account deficit - which could be interpreted as a case in which Americans, in total, don't save enough and thus must rely more on the savings of foreigners (thereby contributing to a current account deficit) - you simply can not find today's mercantilists calling for any dramatic lowering of U.S. tax rates and tax burdens. And to the extent mercantilists rail against U.S. current account deficits, they rail against Americans benefiting from the savings of foreigners. They are bolstered in this by their Keynesian cohorts, who insist that economies are prone to bouts of allegedly "excessive saving."

In closing, I must take issue with your view that "the savings rate [might be] restored by severe market corrections." Perhaps you're referring to the fact that when the stock market does well, households tend to save less out of disposable income - and that they tend to save more out of income if the stock market declines or performs poorly. That's true. But surely this would be a perverse strategy for reversing the low household savings rate in the U.S. Why not aim for both rising stock prices and more savings? You conclude by describing a stock-market decline or plunge as a "correction," which implies that any prolonged rise in stock prices is somehow "mistaken." But if we're to be benevolent about wealth creation - which stock prices certainly reflect - then we must assume wealth-creation (and a rising stock market) to be the norm (the "correct") in life; equally, we must view the destruction (or loss) of wealth as the abnormal (the "mistaken"). A metaphor might make my point clearer: If we've been healthy, but then become sick, we don't say our illness "corrects" our former state; we see our illness as an abnormal state to be remedied.

Richard M. Salsman, CFA

President & Chief Market Strategist

InterMarket Forecasting, Inc.

1777 Fordham Boulevard - Suite 202-4

Chapel Hill, North Carolina  27514



IFI is an investment research and forecasting firm that quantifies market-price indicators to guide the asset allocation decisions and trading strategies of pension plans, asset managers, financial institutions and hedge funds.

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