Trade deficits come due some­day

The Pak Banker - - OPINION - Noah Smith

IN a re­cent in­ter­view on the EconTalk pod­cast, Mas­sachusetts In­sti­tute of Tech­nol­ogy econ­o­mist David Au­tor said that a trade deficit rep­re­sents a loan that has to be paid back. This is an im­por­tant is­sue, since the U.S. has run a large trade deficit for sev­eral decades now.I was happy to hear some­one talk about this fact, which is rarely ac­knowl­edged. But not ev­ery­one was pleased.

When I re­peated Au­tor's state­ment, Dan Iken­son, di­rec­tor of the Her­bert A. Steifel Cen­ter for Trade Pol­icy Stud­ies at the Cato In­sti­tute, said that I don't un­der­stand how trade works, So what does the U.S. give Ger­many in ex­change? It could send over a real, us­able good or ser­vice -- some bushels of corn, per­haps, or some copies of Win­dows 10. If the U.S. gives corn and soft­ware equal to the value of the car, that's called bal­anced trade. Al­ter­na­tively, if the U.S. doesn't feel like grow­ing any corn or writ­ing any soft­ware to­day, it could write Ger­many an IOU. The U.S. could pay for the car not with corn or soft­ware, but with dol­lar bills. The Ger­mans might then use the dol­lar bills to buy some long-term Amer­i­can fi­nan­cial as­set, such as a U.S. Trea­sury bond or some shares of Ap­ple stock. In this case, we say that the U.S. ran a trade deficit with Ger­many, be­cause it got some­thing of real value from Ger­many (a car), while all Ger­many got in re­turn was a slip of pa­per.

But at some point, Ger­many is go­ing to want to ex­change its slip of pa­per for some­thing of real value -- some­thing some Ger­man per­son can use and en­joy. Who­ever in Ger­many is hold­ing onto the Amer­i­can fi­nan­cial as­set can't use it within his or her own coun­try -- Ger­many uses euros, not dol­lars! He or she could sell the dol­lar-val­ued as­set to an­other Ger­man for a euro-val­ued as­set, but that just de­lays the is­sue -- at some point, some­one is go­ing to de­cide to use the dol­lar- val­ued as­set to get some­thing of real, us­able value. And where do you spend dol­lars? In the U.S.At that point, the Ger­man will sell his or her dol­lar-val­ued as­set for dol­lars, and use those dol­lars to pur­chase some real good or ser­vice from the U.S. At that point, the U.S. will run a trade sur­plus, and Ger­many will run a trade deficit. The scales will bal­ance out. The U.S. will get a slip of pa­per, and Ger­many will re­ceive some item of real value in re­turn.

This ex­am­ple il­lus­trates why a trade deficit is a loan of real goods and ser­vices. The coun­try run­ning a trade sur­plus is giv­ing up value -- do­ing real work, us­ing up real time and re­sources -- in ex­change only for pa­per prom­ises. At some point in the fu­ture, the coun­try now get­ting those pa­per prom­ises is go­ing to want some­thing of real value in re­turn, and at that time it will be able to get those things with­out any ef­fort or ex­pen­di­ture of re­sources.

Now, there are sev­eral ways in which one of the trad­ing part­ners can end up walk­ing away with more value than the other.

The first way is a de­fault. The fi­nan­cial as­set that is be­ing held by some­one in Ger­many could be­come worth­less be­fore it can be ex­changed for some­thing real. The U.S. govern­ment could choose to de­fault on its sov­er­eign debt, lead­ing to a plunge in the value of Trea­sury bonds. Or Ap­ple could go bust, send­ing the value of its shares to zero. If this hap­pens, no one in Ger­many will ever be able to re­coup the full value of the car that was given to the U.S. The U.S. will have got- ten some­thing for lit­tle or noth­ing (al­though a de­fault would prob­a­bly end up hurt­ing the U.S. econ­omy).The se­cond way is in­fla­tion, which rep­re­sents a par­tial de­fault. U.S. in­fla­tion could rise, mean­ing that a dol­lar pur­chases less in real value than it used to. In this case, the Ger­man hold­ing on to the U.S. fi­nan­cial as­set, wait­ing to make a pur­chase, is out of luck.

The third way is via a ma­nip­u­lated ex­change rate. Through com­pli­cated tech­niques such as cap­i­tal con­trols and ster­il­iza­tion, it is pos­si­ble for a coun­try to swap goods and ser­vices in ex­change for goods and ser­vices of lesser value. Sup­pose that pri­vate Ger­man cit­i­zens, for some rea­son, would de­mand U.S. fi­nan­cial as­sets worth 5,000 bushels of corn in ex­change for one Volk­swa­gen Jetta. But the Ger­man govern­ment -- which wants to nur­ture its au­to­mo­bile in­dus­try by en­cour­ag­ing higher pro­duc­tion vol­umes -- de­cides to make them trade the Jetta for fi­nan­cial as­sets worth only 3,000 bushels of corn. In this case, Ger­many will be get­ting less than fair value for its car. This is sim­i­lar to what many peo­ple be­lieve China was do­ing with the U. S. in the 2000s.So a trade deficit does rep­re­sent a loan, but that loan doesn't al­ways have to be paid back in full, and the terms of the loan can some­times be un­fairly fa­vor­able to the bor­rower. Nev­er­the­less, most of what we get from our trade deficits will have to be paid back some­day.

Newspapers in English

Newspapers from Pakistan

© PressReader. All rights reserved.