Scott Sumner  

Why America can run trade deficits forever

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Here's the Financial Times:

China's provision of development finance to the emerging world has always been about much more than building infrastructure to reap a commercial return. It has also been about changing destinies. Beijing selected countries that it aimed to lift from poverty, while forging political alliances and creating markets for Chinese goods. The defining characteristic of China's power projection is its ability to get things done.

Thus, a mounting economic crisis in Venezuela comes as a big blow. Caracas is the biggest client of China's state-orchestrated development lending, accepting some $65bn in loans since 2007 for projects such as oil refineries, gold mines and railways. But in May this year, Venezuela engineered a default under which it has deferred paying the principal -- and only honours the interest -- on outstanding debts estimated at $20bn-$24bn.

Worse may be yet to come. Venezuelan inflation is running at about 800 per cent and a chronic shortage of US dollars is preventing Caracas from paying some of the contractors that keep its oil supplies flowing. Since China's loans are secured against this dwindling output of oil, pulses are racing in Beijing. In addition, some of the projects undertaken with Chinese money, including a partly built high-speed railway, have been vandalised and abandoned.


The US has been running large current account deficits for many decades. Commenters often suggest that this means we are becoming a debtor nation, living beyond our means. This is not true.

The US earns more from our foreign investments overseas that foreigners earn on their investments in the US. China earns $65 billion selling goods to the US, and fritters the money away in loans to places like Venezuela. Meanwhile our multinational corporations make shrewd investments overseas, which bring lots of money back to the US economy.

The international accounts balance out perfectly, once you include trade in goods, services, and assets. The overall balance of payments deficit is precisely zero, if measured properly. Some countries, such as China, are relatively good at exporting goods. They run a positive trade balance. The US is relatively good at international investment---we run a persistent trade deficit, financed by our profits on overseas investments. Or we sell the Chinese "goods" such as houses in LA, that don't count as US exports because they are not physically moved overseas.

Our balance of payments accounting doesn't really correspond to what's going on in the real world. If we sold the Chinese mobile homes, and put them on a ship to China, they'd count as exports. It sounds crazy, and it is, but that's how the accounting is done.

This does not mean that we live beyond our means. GDP in the US is much larger than US consumption. Over time, we are becoming wealthier and wealthier. If countries like China ever became more adept at international investment, then the US would have to share a greater proportion of its GDP with the rest of the world.

Most importantly, the current trade balance is not "unsustainable", and there need not ever be a "day of reckoning." Some bloggers obsess over international "imbalances"---ignore them. Countries with large current account deficits may have debt problems (i.e. Greece in the early 2000s) but the problem is not the CA deficit per se, it's the excessive debt.




COMMENTS (26 to date)
Market Fiscalist writes:

Great post!

On "If we sold the Chinese mobile homes, and put them on a ship to China, they'd count as exports. It sounds crazy, and it is, but that's how the accounting is done."

And I bet if you asked, a lot of people would say that exporting mobile homes would be good for the economy , while selling US-based property to foreigners is somehow bad.

foosion writes:

I believe the usual claim compares these two cases:

1) US person buys a widget made in the US. US persons made the widget and money ends up in the US.

2) US person buys a widget made in China. Chinese person made the widget. Now money is in China. Chinese person buys a US financial asset, so money ends up in the US.

Less US labor in the second case than the first, which is not as good for US workers.

Philo writes:

@ foosion:

In 2), the U.S. gets a widget with less U.S. labor. This is not bad for the U.S. If we could get everything we want with no labor, that would, in fact, be supremely good. Also, in 2), Chinese person invests in U.S. asset. Is this bad for U.S. workers? Is all investment bad for U.S. workers? (The answer is 'no'. Investment tends to make workers more productive, hence is good for them. Of course, investment may have taken place also in 1), but it certainly did in 2).)

BC writes:

@foosion, In (2) what does the American selling the financial asset to the Chinese person do with the cash? He buys another good or service provided by a US worker.

The Chinese person made a widget. If he just gave it away to us for free, that would be good for us. Alas, he probably expects something in return, a US-made good. When the Chinese person buys a financial asset, he is just trading current consumption for consumption in the future. His counterparty will get the current consumption, produced by US labor. If the Chinese person never takes any consumption, perpetually trading for future consumption, then that is like giving us a free widget.

BC writes:

One aspect of trade with China that rarely seems to come up (surprisingly) is that they are our geopolitical rival. When we buy widgets from them, they can trade for military goods (or raw materials used in the production of military goods), which can undermine our security interests, say in the South China Sea. If we only had bilateral trade, we could limit exports of military goods but, with multilateral trade, China can import military or raw goods from third parties that import non-military goods from us.

In the same way that our own military goods are public goods, Chinese military goods seem to be some sort of negative public good (public bad?). The negative security is spread non-excludably among everyone, not just the consumers of Chinese imports. We pay for our own military (and other public) goods with taxes. Would taxing Chinese imports be the economically most efficient way of internalizing the negative security externality of trade with China or is there some other way to think (economically) about this?

Mark Bahner writes:
...which can undermine our security interests, say in the South China Sea.

What security interests do we have in the South China Sea?

Scott Sumner writes:

Market, You said:

"And I bet if you asked, a lot of people would say that exporting mobile homes would be good for the economy , while selling US-based property to foreigners is somehow bad."

Yup.

foosion, Yes, that's the claim, but of course it's wrong. If we run a CA deficit then I > S, so there are more jobs in investment to make up for the loss of jobs in trade.

BC, Mark's reaction was the same as mine. We think we have security interests in that region, but we'd be better off ignoring it.

Morgan writes:

"This does not mean that we live beyond our means. GDP in the US is much larger than US consumption"

This GDP vs. consumption thing seems like a really useful concept. Can anyone tell me where I can get, or how I can estimate, the "consumption" part? I'd love to compare the US vs., say, Venezuela, China, Zimbabwe, or France.

BC writes:

Re: South China Sea. We have an interest in Freedom of Navigation throughout the globe and maintaining a norm that such matters are resolved in accordance with international law, in this case UNCLOS. We also have an interest in maintaining norms against bully nations unilaterally expanding their sovereign territorial claims.

Suppose we liked to shop at a mall, where customers typically park at a nearby public parking lot. One day, one of the store owners, who also happens to be a mobster, decides to claim that the entire parking lot actually belongs to him. He promises for now to allow customers (of all stores) to continue using the lot, as long as they seek his permission. He also starts posting armed security guards in the lot to assert his ownership claims. One might think that, even though we merely shop there and don't own any of the neighboring stores, that we still have an interest in how the situation is resolved, especially since we shop at and own stores at other malls, which also have mobsters as tenants, and the situation at this mall will set precedent for the others. We might also think that we have an interest in deploying security guards that are not controlled by organized crime, even if other customers and store owners "free ride" on our security. There is no government law enforcement; it's up to us, other customers, and store owners to provide our own private security arrangements.

However, I don't really want to argue the merits of isolationism. My question admittedly assumes a non-isolationist foreign policy as given and asks how to economically efficiently implement non-isolationist goals. Even though buying (legal) products from a mob-owned store is mutually beneficial for customer and mob owner, how does one deal with the externality that such commerce allows the mob owner to obtain more weapons for carrying out more organized crime?

Mr. Econotarian writes:

Real Personal Consumption Expenditures (PCEC96)

Aug 2016: 11.548 trillion chained 2009 dollars.

US GDP: Q2 2016 18.45 trillion (current US dollars I assume).

Both are Seasonally Adjusted Annual Rates.

Joe B writes:

Well...

Then what would be the result of 500 billion dollars of new foreign demand for American goods and services, resulting in a trade balance?

Also, who is better off, renters or rentiers?

Joe B. writes:

Also:

The US has a property class that restricts property development, creating artificial scarcity, especially in housing where people want to live.

And we have a ruling class that accepts or even embraces a $500 billion a year trade deficit, and says "No matter, the rich foreigners will buy US housing."

Of course, rich Americans and the propertied class benefit from such a confluence of policies.

The middle class? Probably not.

ChrisA writes:

Here is some data on PCE as percentage of GDP across the world;

http://data.worldbank.org/indicator/NE.CON.PETC.ZS

It seems that almost every country is below 100%. Presumably the remainder between PCE and total GDP goes into investment and savings?

Don Boudreaux writes:

Scott,

Nice job - but why do you suggest that America's trade (or current-account) deficit requires that Americans consistently earn profits on their foreign investments? It seems to me that all that is required for Americans to run capital-account surpluses consistently or even indefinitely is that foreigners continue, year after year, to find America to be a relatively more attractive place to invest than Americans find non-American places. Indeed, if we Americans were so very good at investing abroad that we consistently profit on most such investments, that reality - by steadily increasing our foreign investments relative to foreigners' investments in America - would put downward pressure on our current-account deficit.

Sincere question: What am I missing that causes me not to see that (if I correctly understand your argument) we Americans must consistently earn high returns on our investments abroad in order for us to continue to run capital-account surpluses?

Phil writes:

A perpetuation of this transfer will lead to major trouble. To understand why, take a wildly fanciful trip with me to two isolated, side-by-side islands of equal size, Squanderville and Thriftville. Land is the only capital asset on these islands, and their communities are primitive, needing only food and producing only food. Working eight hours a day, in fact, each inhabitant can produce enough food to sustain himself or herself. And for a long time that's how things go along. On each island everybody works the prescribed eight hours a day, which means that each society is self-sufficient.

Eventually, though, the industrious citizens of Thriftville decide to do some serious saving and investing, and they start to work 16 hours a day. In this mode they continue to live off the food they produce in eight hours of work but begin exporting an equal amount to their one and only trading outlet, Squanderville.

The citizens of Squanderville are ecstatic about this turn of events, since they can now live their lives free from toil but eat as well as ever. Oh, yes, there's a quid pro quo--but to the Squanders, it seems harmless: All that the Thrifts want in exchange for their food is Squanderbonds (which are denominated, naturally, in Squanderbucks).

Over time Thriftville accumulates an enormous amount of these bonds, which at their core represent claim checks on the future output of Squanderville. A few pundits in Squanderville smell trouble coming. They foresee that for the Squanders both to eat and to pay off--or simply service--the debt they're piling up will eventually require them to work more than eight hours a day. But the residents of Squanderville are in no mood to listen to such doomsaying.

Meanwhile, the citizens of Thriftville begin to get nervous. Just how good, they ask, are the IOUs of a shiftless island? So the Thrifts change strategy: Though they continue to hold some bonds, they sell most of them to Squanderville residents for Squanderbucks and use the proceeds to buy Squanderville land. And eventually the Thrifts own all of Squanderville.

At that point, the Squanders are forced to deal with an ugly equation: They must now not only return to working eight hours a day in order to eat--they have nothing left to trade--but must also work additional hours to service their debt and pay Thriftville rent on the land so imprudently sold. In effect, Squanderville has been colonized by purchase rather than conquest.

It can be argued, of course, that the present value of the future production that Squanderville must forever ship to Thriftville only equates to the production Thriftville initially gave up and that therefore both have received a fair deal. But since one generation of Squanders gets the free ride and future generations pay in perpetuity for it, there are--in economist talk--some pretty dramatic "intergenerational inequities."

http://archive.fortune.com/magazines/fortune/fortune_archive/2003/11/10/352872/index.htm

Don Boudreaux writes:

Phil:

The scenario you describe is possible. But it does not undermine the larger point made by Scott. The reason is that you implicitly assume throughout your tale that all of Squanderville's trade deficit becomes Squanderville's debt and that none, or too little, of that debt is used to finance the production of capital that will increase future output in Squanderville. Given the name of that mythical country, that is not a bad assumption.

But in reality any real country can run a trade (or current-account) deficit without incurring a smidgen of debt - such as, for example, when producers in country F simply hold some of the currency they earn by selling goods to denizens of country D, or when producers in country F use some of these earnings to buy shares of stock in businesses headquartered in country D, or when producers in country F use some of these earnings to build factories or retail outlets in country D.

When Ikea, for example, builds a store in Newark, New Jersey, the stock of capital in America increases as the U.S. trade 'deficit' thereby rises. It's true that some higher proportion of capital in the U.S. is now owned by people whose passports are issued by a foreign government, but so what? From my perspective as an American I am no poorer because of this Swedish investment in NJ, and I am likely wealthier: I can now get more furniture at lower prices and, perhaps, I might even get a better job working at that Ikea store (or, alternatively, my wage in my current job at Acme Furniture Retailer in Hackensack, NJ, might be bid up due to the resulting additional competition for workers such as myself)

There are other reasons why your tale fails to capture the full range of reasons why country D's consistent trade deficits are not necessarily a problem for the people of country D, but I'll not list them here.

In reality, country D's consistent trade deficits in fact do not imply that country D is mortgaging its future to foreigners. Country D's trade deficit might very well be both a signal that the people and economy of country D are growing stronger and more prosperous over the long run and fuel for that stronger growth, for stronger growth in country D is what more capital investment in country D's private economy causes regardless of the nationalities of the investors. (The trade deficits that the U.S. has run for most of its history are almost certainly generally of this happy sort. Witness, for example, the British investments that helped in the 19th century to finance the building of railways in America.)

Further, the fact that country D's trade deficit, in any particular circumstance, might in fact be the result of such mortgaging as you describe in your tale is a reflection not of trade policy but of the high time preferences (or, if you prefer, the economic myopia) of citizens of country D. High-time-preferences (or myopia) among the citizens of D - whether expressed purely privately or through the agency of government borrowing - might indeed be a problem, but it is neither one that will be solved by trade restrictions nor one that even requires that the citizens of D trade with foreigners at all. Such profligacy as you rightly suggest is damaging over the long run is perfectly possible to play out exclusively within the borders of country D, without D running a trade deficit.

TeeJaw writes:
The US earns more from our foreign investments overseas that foreigners earn on their investments in the US. China earns $65 billion selling goods to the US, and fritters the money away in loans to places like Venezuela. Meanwhile our multinational corporations make shrewd investments overseas, which bring lots of money back to the US economy.

Lots of money from foreign investment remains parked in place because of the punitive U.S. tax rate applied to it when it’s brought back.

Don Boudreaux writes:

For anyone who might be interested, I expand here on my comment above to Phil.

Scott Sumner writes:

BC, I agree that China should adhere to UNCLOS, but if the Philippines doesn't seem too upset, I don't know why we should obsess over it.

The world is full of unfair things; Russia's seizure of the Crimea was 100 times worse, as people actually live in that region. An inhabited reef is not something to lose sleep over.

Don, I agree with you, and certainly didn't mean to leave that impression. I think what I meant was that if the Chinese invested more wisely, then ceteris paribus the US trade deficit would get smaller. But I agree that we can run a trade deficit whether we are earning money on overseas investments, or not.

Thanks for replying to Phil, and saving me the time.

Phil writes:

@Don

you seem to understand this better than I do

How can we tell whether or not a trade deficit is due to "more capital investment in country D's private economy" or due to "the high time preferences (or, if you prefer, the economic myopia) of citizens of country D"?

Matthew Waters writes:

"Lots of money from foreign investment remains parked in place because of the punitive U.S. tax rate applied to it when it’s brought back."

It's not really in foreign investments though. Most foreign subsidiaries would actually have American bank accounts and be managed by Americans.

In the case of Apple, Apple had three legitimate Irish corporations which sold outside of North and South America. If somebody bought an iPhone in Germany, some money would go to license fees to Apple's US corporation but most would stay in ownership of an Irish corporation. The money would actually be transferred from the German seller to an American bank account, where American assets would be bought.

Most other such structures also have American bank accounts, American assets and American management. Without getting into tax policy issues, the tax avoidance strategies actually lead to more demand for American assets, as Apple and other corporations have incentives to not repatriate income and invest it in Treasuries.

Michael Rulle writes:

I remember reading (20 years ago plus) that we earn more on overseas investments than foreigners earn on US investment despite that fact that we presumably invest less in absolute dollars due to our trade deficit. Interesting it is still true. Foreign investment in the US seems highly skewed to financial assets (Gov. Bonds e.g.) versus our tendency to skew investments toward real assets which likely explains it.

When Japan was the other side of this trade instead of China, I used to think it was absurd that we got both great cars and technology and we could sell golf courses (Pebble Beach) and real estate at absurdly high prices. I never understood why there was this mania about the superiority of their economic system.

China does not buy golf courses, but they do buy our Social Security obligations. I suppose one could call that "investment" which is just a word. Any other word would do as long as the accounting statements balance.

Scott Sumner writes:

TeeJaw, True, but the money is owned by Americans, and thus factors into a consolidated balance sheet of our citizens.

Matthew, Thanks, I did not know that.

Michael, I agree.

Benjamin Cole writes:

[Comment removed. Please consult our comment policies and check your email for explanation.--Econlib Ed.]

Bob Murphy writes:

Phil, check this post out. It just elaborates on your scenario.

The question is an empirical one. Massive trade deficits *could* be the result of the phenomenal investment opportunities in the US vis-a-vis the rest of the world that make Americans richer, or they could be the result of Americans living beyond their means. I don't think Scott's particular arguments in this post do much to help us evaluate the situation.

Aaron S. writes:

I am a bit concerned with this post for several reasons, however I assume some of my concern is on account of my own lack of understanding of some concepts. I am concerned with this post as it seems to suggest that it is okay for the United States to never recover from it’s debt, in fact not really worry about how large it becomes. I understand that the United States makes up for the seemingly tremendous amount of owed money by making the minimum payments, not necessarily in a default state yet, and that we are certainly not the only country with a large deficit. I do not understand how it can be beneficial to not care to ever pay off our debt, and thus potentially make a tremendous amount of money. This article seems to brush off the possibility of any foreign country demanding payout on the basis that they would all be too busy paying their own debt and investing in themselves. I am hesitant to assume the actions of foreign leaders to be as predictable as this. Nations of the world with strong authoritarian governments, and few decision makers have been proven throughout history to do unpredictable things and it would seem foolish to guarantee another country will never demand any outstanding balance especially if they find themselves in a time of crisis.
I also wonder what other wonderful things could be done with the increase in disposable income of the American government if we no longer had such heavy loan payments. I think of how much we could lower taxes, fund large construction projects, or research medicine and technology. I would imagine if the United States were to create a way to pay off most of it’s debt, we would find ourselves in a much more powerful and comfortable position, and see a new era of internal investment and advancement.
It seems to be suggested that as long as other countries do not catch up to the level of international investments we have, then we will never have to share more of our GDP with the world. I don’t understand how it is safe to say that we will never need to pay off our debt, because we will never have to share ore of our GDP with the word, because other countries will never catch up to our level of international investments.
As I stated before, I hope that much of my concern can be cleared up upon further education on the topic, however it makes little sense to me, on a very basic level, how it is perfectly fine to never worry about paying for what we owe.

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