It seems that most people who are concerned about the trade deficit are bothered by the fact that the U.S. imports more than it exports. But they forget (or perhaps never knew): An increase in imports causes an increase in the happiness of U.S. consumers. In contrast, AN INCREASE IN EXPORTS REPRESENTS A DECREASE IN THE HAPPINESS OF U.S. CONSUMERS BECAUSE IT MEANS THERE ARE LESS GOODS AND SERVICES FOR AMERICANS TO CONSUME. Exports are simply the price we pay to enjoy imports. Once that is understood, a lot of trade policies that pass for wisdom are exposed as plain old foolishness.
For example, why would the U.S. government ever want to put pressure on its trading partners to buy more American goods? It should be doing the opposite. If the elected representatives of the United States really wanted to help ordinary Americans, they should pressure other countries to subsidize their exports to the U.S.
Or how about this one? The U.S. Treasury Department and Federal Reserve often conspire with the central banks of other countries to prop up their currencies against the dollar. For example, the official policy of the U.S. in 1994 was to keep the Mexican peso from declining in value against the dollar. When the Mexican peso is strong, it makes Mexican goods more expensive for Americans to import. Similarly, a strong Mexican peso makes American goods cheaper for Mexicans, and encourages the flight of U.S. goods and services south of the border and out of the hands of American consumers. So why would the U.S. government work hard to make sure its citizens get less foreign goods to consume, but have to give up more of their own goods and services in exchange? Who are these guys working for, anyway?1
So why do so many people get confused on trade issues? That's a hard question to answer. However, it's our experience that most people get confused because they tend to think of a country as a firm. That is, when a firm takes in less money than it spends, it earns losses. So when a country takes in less money than it spends, it seems only natural to think that the country is in trouble. The difference is that a country is not a firm. The goal of a firm is to maximize profits. The goal of a country is to maximize the happiness it gets from consumption.
When more money consistently enters a firm than leaves that firm, its shareholders are enriched. In contrast, when more money consistently enters a country than leaves that country, its citizens are impoverished. Because that means that lots of goods and services are leaving the country, while only a few goods and services are coming back in. As always, the trick is to keep one's eyes on the ball: Happiness doesn't come from little green pieces of paper, it comes from the consumption that those little green pieces of paper will buy. Can it really be this simple you say? The short answer to this question is "yes." But we confess, there is a little more to this story.
The main reason the dollar value of American imports is larger than the dollar value of American exports is not because foreign nations aren't spending their American dollars.2 Rather, they're spending their dollars investing in our country, instead of buying our goods and services.3 For example, suppose the Japanese sells us camcorders. But rather than use their dollars to buy American computers, they use their dollars to buy the firms that produce those personal computers. Hah! Now that changes everything! Right? Not exactly.
Let's think of why the Japanese would want to own American firms. Presumably, Japanese investors have the same motivation for owning American firms as American investors do. They want to make money. But what will they do with that extra money? Perhaps they'll buy some more firms. Then they'll be able to make even more money. At some point, however, we have to come to grips with the ultimate reason for why Japanese investors want to make all this money. It's the same reason why American investors want to make more money. The reason they want to make those extra dollars is so they can buy more (American) goods and services.
Yup, we're back where we started from: For the most part, Americans pay for imports by giving up goods and services in return. When a Japanese investor chooses to buy an American firm instead of American goods, he's really saying that--rather than having some American goods right now--he'd rather have even more American goods later. Buying a company, or commercial property, or Treasury Bills, is like buying a stream of future American goods and services. In fact, once this is understood, the overall trade deficit can be understood as a loan by foreigners to Americans. They agree to give Americans goods and services now. In return, Americans agree to send goods and services back to the foreigners, later.
Well, isn't that bad for Americans? There are a lot of ways we can answer this. How about this one: Do YOU have any loans? Do you think that loans have made YOUR life worse off? Suppose we outlawed all loans. Would you be made better or worse off? Most people would agree that the ability to borrow money has improved their quality of life. If someone felt that borrowing money would make them worse off, they could always choose not to borrow. If the ability to borrow money is good for any one individual, how can it be bad when we put a bunch of individuals all in one country and call them Americans?
Does this mean that the standard of living of Americans is going to fall in the future when it comes time to pay off all those loans? That depends. Again, think of yourself. Is your standard of living going to be lower because you borrow money? The answer depends on what you choose to spend the money on.
Suppose you zip out your Visa card and decide to have the vacation of a lifetime. You jet to Acapulco. You spend a glorious month in the sun, drinking Margaritas and writing postcards to all your friends back at home (just to make them jealous). You stay in the Penthouse suite. You order all your meals through room service. The hotel masseuse comes to your room to give you a stress-relieving, mind-numbing, absolutely delicious massage in the comfort of your own room...three times a day. It's quite a vacation all right. Yessiree. You go back home and everything is just wonderful until one day you get your Visa bill in the mail. And you spend the rest of your life working three jobs to pay it off! In this case, consuming a lot of extra goods now means that you will have to sacrifice future happiness as you pay off those loans in the future.
But not all loans make one poorer in the future. For example, most students borrow money to help pay for their college education. Sure, they'll have to use some of their future income to pay back those loans. But they're banking that the education they receive will make them richer in the future. So much richer, in fact, that even after they subtract their loan payments, their take home pay will be higher as a result of their educational investments.
So what is America doing with all those loans it is receiving from foreigners? Is it enjoying a huge consumption binge? Or is all this borrowing allowing it to invest in its future production capacity? The fact is, nobody knows. And, ultimately, it really doesn't make a difference. Because the most important thing to keep in mind about the trade deficit is...the U.S. is getting a bunch of great stuff.4 Whatever the reason, we're made better off. Maybe it's because foreigners are trading their merchandise for our goods. Maybe it's because foreigners are trading their merchandise for our services. Or maybe it's because foreigners are willing to make loans to us at rates lower than what we're willing to lend to ourselves. This is essentially what happens whenever foreigners pay more for American firms, commercial properties, and government securities than Americans are willing to pay. A full understanding of how this makes Americans better off must wait until we have a chance to talk about financial markets, and interest rates. It just so happens that this is the subject of our very next chapter.
Notes
1
Interventions in international currency markets such as this are often described as "leaning against the wind." A more apt characterization would be "spitting against the wind." When central banks attempt to resist market forces pushing down the value of a particular currency, they only delay the eventual outcome. Disastrous consequences often follow, as the pent-up forces causing the depreciation eventually prevail, resulting in economic havoc. Such was the case in December 1994 when the Mexican and American authorities stopped trying to artificially prop up the value of the peso. The result was a tumultuous decline in the value of the peso that shook international financial markets and destabilized the Mexican government. If price controls are a bad idea in domestic markets, why would one think they were a good idea in international markets? Like spitting in the wind, such policies are ultimately helpless in fighting market-driven "headwinds."2
To be sure, some of the trade deficit, a small portion, is due to this. Because American dollars are useful in international commerce, many nations hold cash balances of dollars to facilitate their trade with other countries. When this happens, it is Christmas, plain and simple: the U.S. gets valuable goods and services in return for little green pieces of paper.3
It should be noted that, sometimes, what gets reported as the "trade deficit" is actually the "merchandise trade deficit." For example, suppose that instead of buying personal computers with the money they earn for selling camcorders to America, the Japanese purchase other, non-"merchandise" things. Like what? A significant portion of the trade deficit, but not the majority, is accounted for by "services." For example, when Japanese tourists fly American airlines and stay at U.S. hotels, that gets figured into services. Well, you ask, why should it make a difference whether those camcorders get paid for with American personal computers, or romantic nights for Mr. and Mrs. Hayashi at an American Hilton? Exactly.4
Many economists point out that much of the borrowing represented by the trade deficit during the 1980s was the result of government deficit spending. If the trade deficit is a result of government spending and the government spends the money unwisely, then the trade deficit very well could make us worse off. Of course, the problem here is not the trade deficit, but the government spending which is driving it.
CONTINUE ON TO THE NEXT CHAPTER