David R. Henderson  

Balance of Payments

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The latest Freeman just came on-line and carries my piece on the Balance of Payments. It's basic economics that many people who read this blog already know but also many probably don't.

Some highlights:

Quick. What's the trade deficit between California and the rest of the world? Don't try Googling it because you won't find an answer. No government agency--or private entity--computes the dollar value of goods that people in the rest of the world sell to or buy from Californians. Why not? Because it doesn't matter.

Yet governments do that computation for countries. Do trade deficits between countries matter? They do, but a lot less than most people think. A high trade deficit is not a definite sign of an economy's weakness, and a low trade deficit or high trade surplus is not a definite sign of an economy's strength.

What if the money doesn't come back in any of the above three forms of investment but, instead, is held in U.S. dollars? That's even better for Americans. Instead of giving up capital in return for merchandise, we are giving up paper money. According to the Bureau of Engraving and Printing, the average cost of a unit of paper money is 6.4 cents. Because of the production process, the cost is probably higher for a one-hundred-dollar bill, and presumably a disproportionately high number of such bills is held abroad. But it's still likely to cost under 25 cents to print a one-hundred-dollar bill, and the bills take an average of 89 months to wear out. Getting valuable goods in return for paper money that sells for dollars on the penny is a good deal for Americans. Jay Leno, in a 1980s ad for Doritos, said "Crunch all you want. We'll make more." Similarly, if people in other countries hold on to their paper U.S. bills, the Federal Reserve can make more.

And, of course, I also tell of Michael Dukakis's attack of foot-in-mouth disease during the 1988 presidential campaign.

HT to Jeff Hummel for looking it over before publication.

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CATEGORIES: International Trade

COMMENTS (13 to date)
Zdeno writes:

Hi David,

While I certainly agree with many points of your analysis, I think it's definitely worth worrying about the American trade deficit.

Consider the analogy of a wealthy family's "balance of trade" with the rest of the world. If, every year, the family draws down their pool of assets so that they can consume more than they earn, is that not cause for concern? Does our evaluation of the family's fiscal prudence change if we reason that they would be even worse off if the pawn shop and mortgage refinancier refused to lend their services?

No matter what he hears from professional economists, the man on the street is worried to learn that Americans are hocking their capital stock to finance their bloated welfare state, military adventures, and ever-expanding bureaucracy. His views are simplistic, but sometimes, things really are just simple.



David R. Henderson writes:

Good point. And I covered it in the article. Did you read it?

david writes:

As an aside, your choice of California is unfortunate, since (confusingly) California's exports and imports with non-US destinations are indeed well-publicized (since about 10% of US exports leave the US via California). You could have gone with, I don't know, Utah or something. Or go directly with Rothbard's quote about New York and New Jersey.

Also, interstate "exports" and "imports" are also actually recorded, if only to track state sales tax. But you are right in that nobody compiles them and nobody worries unduly about industries moving around within the US.

David R. Henderson writes:

My choice of California is not unfortunate. I said "between California and the rest of the world." The rest of the world includes 49 other states plus D.C. If you can show me net imports between California and the rest of the world, I will concede. Can you?

Zdeno writes:

If I learned anything in school, it's that I can usually get away with reading just the abstract and conclusion. Usually =)

I am sympathetic to the argument that debt run-ups reflect the rational choices made by private actors, and are thus none of my concern. But what percentage of American indebtedness is the result of such decisions? It seems to me that fiscal imprudence mainly flows from a federal government whose responsibility in the matter has ranged from mediocre to criminal for the past century. Do American trade balances really just reflect lower future time orientation? Our enthusiasm for trillion-dollar programs to alleviate the distant, dubious threat of global warming suggests otherwise.

I'm not worried about trade deficits as an end in themselves, but I do think they are symptomatic of the declining quality of American government in general, which is why I disagree with your all-is-sunshine-and-rainbows perspective.

In any case, a thoughtful and well-written article. Pardon the original skim-and-reply.



Garrett Schmitt writes:

I can't find a good number for California's trade surplus/deficit, but there are some data out there from Census. The fact that they have two programs tracking these data yet no official surplus/deficit figure for California does evidence the truth in your assertion that "it doesn't matter" enough to Congress, at least.

Intranational trade:
The Commodity Flow Survey is a newish survey connected to the Economic Census providing one year snapshots every five years.

For California, see Tables 7 and 8 of http://www.census.gov/prod/ec02/ec02tcf-ca.pdf:
Total Outbound Shipments to other US States + DC in 2002: $923,669,000
Total Inbound Shipments from other US States + DC in 2002: $894,487,000

International trade:
I can't find any international import data for California, but there are State Exports data by month and year from 2005-2006 on, focusing on goods going from California to the rest of the world, minus other parts of the US, accounting to some degree for State-of-origin.

Total California International Exports in 2008: $144,806,000 or 152,295,200 (Census has two different series)

All this would be a very messy hodgpodge to assemble into something looking like a merchandise trade deficit. I have no idea, for instance, how the intranational data might double count manufactures included in the international data.

david writes:

@ David Henderson

You can obtain estimates of interstate trade with the Commodity Flow Survey by the Bureau of Transport Statistics. It's not a very good estimate, since it ignores trade in services, but it's an estimate (and, appropriately, your choice of phrasing was "the dollar value of goods that people in the rest of the world sell to or buy from Californians").

The problem is actually finding non-US import numbers for California, which is a fault that the Census Bureau will remedy this month.

The 2002 numbers give California's interstate imports as $894 487 million and exports as $923 669 million (there are 2007 numbers but I can't figure out how to get the BTS website to give them to me).

I'm not trying to disagree with your broader point here, just pointing out that your choice of example is badly chosen.

David R. Henderson writes:

Thanks. I stand corrected.

Garrett Schmitt writes:

Here are the 2007 Commodity Flow Survey data published at Census. They often publish data collected by other departments. It looks like they have an international export series here now, too, though of how it fits with the other export series I am not sure.


Tom West writes:

While I agree in general that trade deficits are not the be-all and end-all, the trouble is that those green pieces of paper that they're holding aren't consumed, unlike the goods and services we bought. They're simply IOUs that can redeemed for real goods from us at some future point.

As a family, I'd be very nervous if someone held 100K worth of IOUs of mine that they could redeem at any point. Perhaps more worryingly, if at some point in the future they don't utterly depend on the value of those IOUs, then they're in a perfect place to pressure one to behave as they would like under the threat of redemption.

However for now, it's the old 'who's got a problem' situation. It's also not to say that I didn't benefit from the goods in the meantime.

(Of course, as a Canadian, my main worry is a massive drop in the US dollar which will sink Canada like a stone because the Canadian dollar is apparently a petro-currency in speculators eyes...)

Colin K writes:

I think the gut concern that the Man On The Street feels is that this arrangement is not sustainable.

1. Holding all things equal, foreign debt will have to be repaid by some combination of (i) inflation, which means I won't be able to buy cheap Chinese gadgets or high-quality European goods; (ii) increased taxation; or (iii) cuts to government services from which I/we benefit.

2. Foreign purchases of assets raise the concern that profits which currently go to domestic consumption will instead go overseas, leading either to more debt (1) or more purchases of assets.

3. Foreign investment is better than (1) and perhaps (to the MOTS) a net positive, but it eventually converges on the situation in (2).

Of course, it's not so simple. GM's profitable operations in China probably do a lot less for American workers than Honda's plants here. Likewise, an American asset owner can spend his profit on a German car just as easily as a German owner can.

And of course, there is no guarantee foreign buyers will invest wisely or successfully--who came out better when a Japanese group bought Rockefeller Center in the 80s?

Still, there is a lingering sense that taken to its logical conclusion, we could end up in a situation where we all work for foreign companies, pay rent to foreign landlords, and all of our taxes go to cover foreign debt.

David R. Henderson writes:

Dear Colin K,
I hesitate to say that there's no substitute for reading my article because we economists tend to believe that there are substitutes for everything. So let me put it this way: there are no good substitutes for reading my article if you're trying to address, as you are, points I dealt with in my article.
One I didn't deal with that you mentioned above is inflation: all else equal, if the inflation rate in the U.S. rises from 0 to 5 percent, the exchange rate between it and a foreign currency that has a 0 inflation rate will adjust to offset the inflation. Net effect: no change in the terms of trade.

Colin K writes:

Prof. Henderson,

Substitutes are unnecessary--I read your article before commenting. I know, what a concept :)

Regarding foreign asset purchases, you write, "Either way, we’re giving up capital for consumption. Is this a bad idea? We’re showing by our actions that we think it’s not." I don't see how this addresses my question except to say "ceci n'est pas un pipe" after a fashion. The relevant choice is not between Toyota Camrys and GM shares, but between Camrys and Chevy Malibus. The balance of trade reflects many things, among them the long-term institutional decline in quality of the Big Three. The sentiment that "we don't make anything anyone wants to buy here anymore" is less than entirely accurate but it's also more than rank superstition.

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