What’s So Bad about the Trade Deficit?

The ravings of a certain candidate for President — in case you have been living under a rock, I mean the one that has been having a bad hair decade — about the evils of the US trade deficits with China, Mexico, Japan, and assorted other countries reminded me of a column I wrote for the New York Times in another election year, 1984 to be exact. So I went back and looked for it, and it seemed sadly still to be relevant, so I will reproduce it here. Not that I expect it to contribute much to general enlightenment, but, at times like these, one feels that one just has to do something to resist the madness.

The Much Maligned Trade Gap

No economic statistic is reported more dolefully these days than the country’s trade balance.

Ever on the alert for signs of impending economic disaster, the press routinely couples reports of record monthly trade deficits with warnings of experts and Government officials of the dangers of the deficit.

Just what is so dangerous about receiving more goods from foreigners than we give them back is never actually explained, but it is often suggested that that it causes a loss of American jobs.

News reports sometimes even provide estimates of the number of jobs lost owing to every billion dollar increase in the trade deficit. Heaven only knows how these estimates are made, but presumably they are based on the assumption that imports deprive Americans of jobs they could have had producing domestic substitutes for the imports.

It almost seems tedious to do so, but it apparently still needs to be pointed out that buying less from foreigners means that they will buy less from us for the simple reason that they will have fewer dollars with which to purchase our products.

Thus, even if reducing imports increases employment in industries that compete with imports, it must also reduce employment in export industries.

Moreover, the notion that the trade deficit destroys domestic jobs is contradicted by the tendency of the deficit to increase during economic expansions and to decrease during contractions.

The demand for imports rises with income, so imports normally tend to rise faster than exports when a country expands more rapidly than its trading partners. The trade deficit is a symptom or rising employment — not the cause of rising unemployment.

That balance-of-trade figures are misunderstood and misused is not surprising, since their function has never been to inform or to enlighten. Their real purpose is to provide spurious statistical and pseudo-scientific support to groups seeking protectionist legislation. These groups try to cloak their appeals to protection with an invocation of the general interest in a favorable balance of trade.

Anyone who has ever thought about it has probably wondered why a country that gives up more goods in trade than it gets back is said to have a favorable balance of trade.

If you have ever wondered about it and couldn’t think of an answer, don’t worry, because you are in good company. Adam Smith couldn’t either. “Nothing,” Smith once observed, “can be more absurd than this whole doctrine of the balance of trade, upon which . . . almost all the . . . regulations of commerce are founded.”

The absurdity of the doctrine ought now to be manifest owing to the current international debt crisis. The crisis, as we all know, arose because large numbers of developing countries are apparently unable to make the scheduled payment on loans to American banks from which they borrowed.

It is, I believe, just about universally acknowledged that it would be a bad thing if the debtor countries failed to repay their loans.

The debtor countries would suffer because they would be less able to borrow in the future, and thus less able to import the products they need to take care of their populations and to promote development.

Creditor countries would  also suffer because default would impose huge losses on the banks and their shareholders. And since such losses might undermine the domestic and international banking systems, they would undoubtedly be made up, at least in part, by the Government and the taxpayers.

Yet it is remarkable how little, even now, the relationship between the ability of the debtor countries to repay their debts and the size of the American trade deficit is understood. For everyone continues to rail against the trade deficit even though reducing it would make the default of the debtor countries all the more likely.

A simple example will help to explain why that is so.

Suppose I borrow money from you and promise to repay you next year. And, for simplicity, suppose that neither of us engages in transactions with third parties. Thus, I produce goods, some of which I consume myself and the rest of which I sell to you, and you produce goods, some of which you consumer and the rest of which you sell to me.

Now the reason that I am borrowing from you is that  the value of the goods I want from you this year exceeds the value of what I am willing to sell you this year. But next year I shall have to sell you enough not only to cover what I buy from you, I shall have to sell you enough to earn the money with which to repay you.

Thus, to avoid default, I must run a trade surplus with you next year. And if you want to be repaid, you have to reconcile yourself to the idea of running a trade deficit, because repayment consists in, and is equivalent to, my trade surplus and your trade deficit.

The debtor nations are faced with default because they haven’t enough dollars to repay the banks from whom they have borrowed. Why not? Because their trade surplus with the United States — our trade deficit with them — is too small for them to earn the dollars they need for repayment.

How could they earn more dollars? 1. They could reduce their imports from us. 2. They could increase their exports to us. 3. They could borrow more dollars from us. 4. We could give them the dollars.

The first two options both imply an increase in our trade deficit. That sounds bad only if you ignore the alternatives. The third option might have some attraction if the debtor countries could repay their existing debts. But since they can’t even do that, further lending seems inadvisable.

The fourth option, it goes without saying, is the economic equivalent of default.

Those who insist that the United States trade deficit must be reduced had better think through the implications. They should ask themselves whether they really want to drive the debtor countries to the wall and whether they are prepared to absorb the losses associated with a default by the debtor countries just to stop American consumers from buying as much of the products of debtor countries as they want.

Allowing unrestricted access of those products into our markets would not necessarily prevent default, but maintaining or tightening restrictions can only increase the likelihood and the severity of an eventual default.

And at a more fundamental level, isn’t there something perverse in first lending to someone, and then, after having refused to accept payment, hauling him into court because he won’t pay his debts?

Which brings to mind the following thought: the very same candidate that is promising to convert the US trade deficit into a trade surplus is also the candidate that wants America’s European and Asian allies to increase their payments to the US to cover the costs incurred by the US in defending them? How does this candidate suppose that these allies can simultaneously increase their dollar payments to the US without either exporting more to, or importing less from, the US. Or perhaps the candidate believes that these allies can just print the money with which to purchase the dollars from the US, and then pay us back with the dollars they acquired with the money they printed. But that would mean that their currencies would depreciate against the dollar. But this candidate doesn’t like it when other countries devalue their currencies against the dollar; the candidate calls that currency manipulation. My oh my, what a tangled web we weave . . .

36 Responses to “What’s So Bad about the Trade Deficit?”


  1. 1 Cole H. June 2, 2016 at 8:02 pm

    Sentence Fragment: “The larger philosophical or methodological point is that although the theory of utility maximization underlying neoclassical theory is certainly useful as a basis for deriving what Samuelson called meaningful theorems – or, in philosophically more defensible terms, refutable predictions — about the effects of changes in specified exogenous variables on prices and output.”

    Too bad, as the incomplete thought derails the conclusion.

  2. 2 Lord June 2, 2016 at 9:34 pm

    The current account deficit has most assuredly cost jobs over past years. Trade and services don’t, but currency manipulation does which is exactly the reason it is done.

  3. 3 peterschaeffer June 2, 2016 at 9:48 pm

    Hopefully, better formatting…

    “Just what is so dangerous about receiving more goods from foreigners than we give them back is never actually explained, but it is often suggested that that it causes a loss of American jobs.”

    It is trivial to devise both theoretical and empirical economic models where trade deficits do reduce total employment. For a very non-theoretical example, see

    “The China Shock: Learning from Labor Market Adjustment to Large Changes in Trade”

    The abstract reads

    “China’s emergence as a great economic power has induced an epochal shift in patterns of world trade. Simultaneously, it has challenged much of the received empirical wisdom about how labor markets adjust to trade shocks. Alongside the heralded consumer benefits of expanded trade are substantial adjustment costs and distributional consequences. These impacts are most visible in the local labor markets in which the industries exposed to foreign competition are concentrated. Adjustment in local labor markets is remarkably slow, with wages and labor-force participation rates remaining depressed and unemployment rates remaining elevated for at least a full decade after the China trade shock commences. Exposed workers experience greater job churning and reduced lifetime income. At the national level, employment has fallen in U.S. industries more exposed to import competition, as expected, but offsetting employment gains in other industries have yet to materialize. Better understanding when and where trade is costly, and how and why it may be beneficial, are key items on the research agenda for trade and labor economists.”

    “It almost seems tedious to do so, but it apparently still needs to be pointed out that buying less from foreigners means that they will buy less from us for the simple reason that they will have fewer dollars with which to purchase our products.”

    Wrong at least three different ways. First, if foreigners have fewer dollars they may still purchase exactly the same quantity of exports from the U.S., while buying less U.S. debt. In other words, reducing imports may both create U.S. jobs and reduce U.S. borrowing. Obviously, that’s a win-win for the USA.

    Second, reducing (some) imports may well increase employment even without any change in the capital account. The economy (the U.S. economy) may move from a low-employment equilibrium with balanced external trade to a high-employment equilibrium with balanced external trade. Hypothetically, if the U.S. restricted imports of consumer goods, the economy might shift to a new equilibrium with higher employment, higher incomes, and ultimately greater imports of income sensitive non-consumer goods.

    Third, if export industries create fewer jobs per dollar than import industries, protectionism can net create jobs even if exports are reduced.

    “Anyone who has ever thought about it has probably wondered why a country that gives up more goods in trade than it gets back is said to have a favorable balance of trade.”

    The answer is trivial. Countries with trade surpluses have income, jobs, net creditor status, and the productive capacity to earn their way in the world. All of those are considered to be “good things”.

    The reverse is also true. Countries that allow imports to gut their domestic economy do not thrive. It is obvious to anyone that quitting your job and relying on your credit cards will end in disaster for any person. However, “sophisticated” economists advocate exactly the same thing for nations. Guess what? They are just as wrong. Using imports to destroy domestic productive capacity and paying for them (the imports) with debt ends badly, indeed very badly. There is a long and dismal track record of countries running vast trade deficits financed with foreign debt and ultimately collapsing. Argentina, Ireland, Spain, Greece, and yes the USA are just the latest examples. The U.S. ran the largest trade deficits in history up to 2008, financed with foreign borrowing. The productive core of the U.S. economy simultaneously imploded under the weight of “free trade” imports. The outcome was completely predictable, a devastating crash.

    “The absurdity of the doctrine ought now to be manifest owing to the current international debt crisis. The crisis, as we all know, arose because large numbers of developing countries are apparently unable to make the scheduled payment on loans to American banks from which they borrowed.”

    The international debt crisis of the early 1980s was mostly in developing countries. 30 years later, the world is a different place. The U.S. runs huge trade deficits with Japan, China, and parts of Europe. These countries and regions can easily handle a balancing of U.S trade. Even if they can’t, that’s not our problem.

    The sad truth is that “free trade” is just personal ideology cloaked in a pretense of economic fact. Quote from Dani Rodrk.

    “My point is not that the economics profession is not on the side of angels in the policy debate over trade liberalization–although I will argue that a more careful argument should lead to a more nuanced view–but that the argument is poorly made. This reflects negatively on the credibility of the economics profession as a whole: critical thinkers might believe all economic arguments are as poorly supported as is the one in support of free trade; others might believe economists are mere propagandists and handmaidens in service of some philosophical or political goal. Furthermore, it obscures some key ideas that should be part of a persuasive argument in support of free trade. And finally, it has confused many people into false beliefs about what economic analysis really says about the effects of international trade.”

    The fact that an economics post contains trivial fallacies (no, lower imports will not always reduce exports) should appall anyone. Like it or not, the “bad hair” presidential candidate has demonstrated a surer grasp of economic principles than much of the economics profession. Of course, the unwillingness of the economics profession to admit that ideology and interest, drive advocacy of “free trade”, rather economic fact(s), makes that inevitable.

  4. 4 Ellie Kesselman June 2, 2016 at 11:35 pm

    The quoted portion was written by David Glasner in 1984. Consider this excerpt:

    “Those who insist that the United States trade deficit must be reduced had better think through the implications. They should ask themselves whether they really want to drive the debtor countries to the wall and whether they are prepared to absorb the losses associated with a default by the debtor countries…”

    This is a hostage’s viewpoint! No nation, and certainly not the USA, should set trade policy from the perspective that debtor countries hold more power than lender countries. In other words, that a lender cannot collect on an obligation, for fear of the harm it might do to the debtor nation’s economy. That sort of attitude was ill-conceived in 1984, and was repudiated by successful debt restructuring, specifically, Brady Bonds. The Brady Bond program of the late 1980s is an example of how debtor nations can successfully emerge from overwhelming debt burdens. Mexico, Argentina and Brazil repaid sovereign debt through Brady Bonds and re-established credit in the global marketplace.

  5. 5 peterschaeffer June 3, 2016 at 11:18 am

    In my view, “free trade” is one of the dogmas (religions really) of our time. It is something that right-thinking people are expected to embrace as a matter of faith without question. Deviations from the orthodoxy are decidedly unwelcome.

    In this context, I am not arguing the merits or demerits of actual trade policy. The real point is the extent to which it has become an idée fixe. As such it paralyzes attempts at serious discussion and ostracizes anyone who dares to ask questions.

    I never thought of trade this way until I read “The Opium Wars”. I was astonished too see the Opium Wars justified as exercises in “free trade”. Phrases like “Free trade is Jesus Christ and Jesus Christ is free trade” were apparently used at that time.

    For a while, Dickens (yes, that Dickens) supported the Confederacy against the Union because the Confederacy advocated “free trade” and the Union was highly protectionist. Madness.

  6. 6 David Glasner June 3, 2016 at 1:10 pm

    Cole, Thanks for being a careful reading. Too bad you didn’t arrive sooner. What was left out was that assumption of utility maximization where utility is simply a function of the consumption of real goods and services is not an appropriate basis for making judgments the overall well-being of individuals and society.

  7. 7 David Glasner June 3, 2016 at 1:15 pm

    “The current account deficit has most assuredly cost jobs over past years. Trade and services don’t, but currency manipulation does which is exactly the reason it is done.”

    Trade and services don’t cost job? What is that supposed to mean? Is your definition of currency manipulation the same as the above-referenced candidate for President? If so, you can’t possibly understand what you are saying. I suggest you look at several of the posts that I have written on the topic applying Max Corden’s paper on exchange rate protection.

  8. 8 David Glasner June 3, 2016 at 2:12 pm

    Peter, I haven’t read the paper whose abstract you have reproduced. Their discussion, which may or may not be true, is orthogonal to my discussion of trade deficits. They are talking about disruptions caused by changes in the pattern of trade that undermine existing industries. I wrote a long post a couple of months ago called “What’s so Great about Free Trade?” in which I said that economists models of utility maximization are very inadequate for dealing with issues about job loss. I agree that when trade causes established industries to decline, the problems that result are much greater than standard economic models imply. As some of my commenters pointed out, the problem is not confined to trade. We see the same problems arising as a result of the decline of the coal industry thanks to a large number of causes, but mainly the availability of cheap natural gas, that have nothing to do with trade policy. So your comment, which raises some problems that I think need to be addressed, has nothing to do with the conceptual incoherence of using the balance of trade as an indicator of the extent to which trade is either helping or hurting a country or the conceptual incoherence of thinking that international debts can be repaid without a corresponding flow of real goods and services reflected in the trade balance.

    You say that, after being stopped from exporting to the US, countries may continue to buy US exports and simply buy less US debt with their reduced holdings of dollars. The countries with reduced exports and fewer dollars will tend to suffer declining real exchange rates which will make US exports less competitive, so US exports to those countries will decline. You suggest the possibility that reducing US imports will somehow lead us from a low level equilibrium to a high level equilibrium. Are you aware of any research that shows that such a transition is likely or that we could know in advance when such a transition would occur? Is there evidence that shows that export industries employ less labor input per dollar of output than import competing industries?

    There is no law of nature that says that countries with trade surpluses are more prosperous than countries with trade deficits. Countries with trade surpluses tend to be countries that save a lot and countries that specialize in producing goods for which there is a high international demand. Trade policy doesn’t determine either the savings rate of a country or the demand for its exports, so you are assuming that the causality goes in the direction of trade policy to prosperity rather than from more fundamental factors to prosperity and trade surplus as a by-product.

  9. 9 David Glasner June 3, 2016 at 2:16 pm

    Ellie, Every debtor is to some extent a hostage to his creditor. Obviously creditors sometimes recognize, unless they are complete idiots as they often are, that insisting on the original terms of the contract is a self-defeating strategy. Adopting your attitude towards debt repayment is not only brutal, it is self-defeating.

    But aside from the question of judgment or ethics, it is just incoherent to tell your international debtor that you expect to be paid back but will not permit the debtor to sell you anything.

  10. 10 David Glasner June 3, 2016 at 2:21 pm

    Peter, This is simply a diatribe. I hope indulging in it makes you feel better.

  11. 11 peterschaeffer June 3, 2016 at 2:47 pm

    Indeed, it is a diatribe and I am making the same point as Dani Rodrik. Advocacy of free trade is an exercise in ideology cloaked in the rhetoric of economic fact. It is an expression of interest disguised as principles. More directly, it is the use of principle to advance principal.

  12. 12 David Glasner June 3, 2016 at 3:23 pm

    Peter, Oh please, as if it’s only one side that cloaks its self-interest in terms of some grander principle.

  13. 13 Jerry Brown June 3, 2016 at 9:56 pm

    Professor Glasner, in your reply to Peterschaeffer at 2:12 , you say that “countries with reduced exports and fewer dollars will tend to suffer declining real exchange rates which will make U.S. exports less competitive, so U.S. exports to these countries will decline.”

    I can understand how that is supposed to happen. But my question is- why hasn’t the reverse happened over the last 35 years for the U.S.? The theory of currency adjustment should work both ways. Why hasn’t it happened that our currency hasn’t declined to the extent that U.S. exports are super competitive at this point? Is it unreasonable to consider that other countries may have policies to hold U.S. dollars in order to prevent the exchange rate adjustments that would occur otherwise, thereby subsidizing their own export sectors, but hurting U.S. producers and labor that have to compete?

  14. 14 doncoffin64 June 4, 2016 at 9:05 pm

    Just out of curiosity, I compiled the data and calculated the correlation coefficient between the trade deficit as a % of GDP and the “GDP Gap” as a % of GDP (=Actual Real GDP minus Potential Real GDP divided by Actual Real GDP). The correlation coefficient is -0.67…a SMLLER GDP gap is STRONGLY related to a LARGER trade deficit.

    Or: “The demand for imports rises with income, so imports normally tend to rise faster than exports when a country expands more rapidly than its trading partners. The trade deficit is a symptom or rising employment — not the cause of rising unemployment.”

  15. 15 doncoffin64 June 5, 2016 at 11:54 am

    Er…a less negative GDP gap or a larger positive GDP gap is strongly reiated to a larger trade deficit. After midnight, my brain cramps.

  16. 16 Frank Restly June 5, 2016 at 2:56 pm

    Let me ask the question this way:

    Why should a country that purchases U. S. government bonds be exempt from the taxation that is utilized to make the payments on those bonds?

    In other words, why shouldn’t Presidential candidate “such and such” assess import tariffs on a country with significant holdings of U. S. government debt to make the payments on that debt?

  17. 17 Frank Restly June 5, 2016 at 3:06 pm

    David,

    “How does this candidate suppose that these allies can simultaneously increase their dollar payments to the US without either exporting more to, or importing less from, the US.”

    They don’t have to increase their dollar repayments to the U. S. They can simply rescind their claims (or have them revoked) on U. S. taxation through their bond holdings.

    Presidential candidate “such and such” can simply pass a law that assesses a tax on international U. S. bond holdings with repayment exclusively in the form of the bonds being returned / destroyed.

  18. 18 Benjamin Cole June 5, 2016 at 10:18 pm

    Well…

    Okay, the US can print money accepted everywhere. So we print slips of paper and get back goods and services. That’s a good deal, even if it means chronic and growing trade deficits, now north of $500 billion a year.

    But, we are also mortgaging our assets, or are prepared to give up chunks of future goods and service produced domestically to offshore buyers when they use those dollars to buy US-made goods and services.

    In other words, ultimately we will have to work for someone else’s benefit (if you subscribe to the idea of modern nations), or sell assets.

    There are also huge structural impediments and institutional imperfections in global trade, and environmental or national security issues. The ability to generate new technology is often related to present manufacturing,

    There may (for some) be issues of human rights.

    If labor unions are illegal in mainland China, and coal miners die by the thousands, is that a system we want to support by buying goods made there? Maybe so, but where is the line? Would you buy goods from Nazi Germany? Myanmar? The Cambodian Khmer Rouge?

    I find the free traders are glib, and besides that free trade is not even that important. Doug Irwin did a study on Smoot Hawley and found it of little consequence.

    President Ronald Reagan was a much more aggressive protectionist in fact than Trump has ever bellowed about. Reagan had 100% tariffs on Japanese electronics, and 50% tariffs on big Japanese motorcycles, and quotas on Japanese auto imports and then at the Plaza Accords rigged up a cheap dollar against the yen. President Reagan declared a trade war on Japan!

    Trump is a little boy in short pants next to Reagan.

    But America flourished under Reagan.

    You know, the topics are always free trade, the minimum wage and immigration.

    The topics are never property zoning and the criminalization of push-cart vending. I would say property zoning and push-cart vending laws are much bigger cramps on trade in America than international trade laws.

    Class bias in topic selection? Maybe so.

    I do not mean this to be about David Glasner, one of my favorite thinkers. I think Glasner is talking about what everybody is talking about, and staying current. That is what bogglers do.

    Talking about property zoning and push-cart vending is not done.

  19. 19 David Glasner June 6, 2016 at 7:45 pm

    Jerry, The simple answer is that my reply to Peter Schaeffer presumed that other things remained equal. Obviously over 35 years, the ceteris paribus assumption, cannot hold, so you can’t draw assume that the dollar exchange rate would adjust sufficiently to eliminate the trade deficit. All I was pointing out was that there would be some tendency for US exports to drop if we were to substantially reduce the amount of imports into the US.

    Don, Nice work, thanks.

    Frank, Are you aware of any country that imposes taxes on the interest paid to non-resident foreigners holding its bonds?

    Benjamin, If we, as a country, are becoming indebted to foreigners, it’s because we are spending beyond our means. The problem is not trade policy, but not enough saving. Are you in favor of the government forcing people to be more thrifty? I don’t know what you think about that, but a lot of people get bent out of shape when they hear that the government doesn’t want them to drink so much sugary soft drinks. Do you think it’s less intrusive for the government to tell you to save more than it is to tell you to consume less sugar? Trade policy is very complicated, and although my predisposition is to be in favor of free trade, as a matter of principle, I think so-called “free trade agreements” are very questionable, because they favor some countries over others and the arguments for free trade are arguments for reducing trade barriers in general not reducing some while leaving others in place. So it’s not clear to me that there is a valid free trade argument in favor of bilateral free trade agreements.

    Also I don’t think that Doug Irwin believes that Smooth-Hawley didn’t matter; I think his view is that it probably was not a big factor in causing the Great Depression. As an empirical matter he may be right, but there is an argument to be made that it helped destabilize the world financial system by making German and Allied war debts uncollectable.

    You keep making the argument that Reagan was a protectionist, and I agree that he did engage in some protectionist policies to protect particular industries like electronics and motorcycles, but there were also tariff reductions and other liberalizations. The decline in the dollar after the Plaza accords only reversed a very steep increase in the value of the dollar in the earlier Reagan years, so I think that you are exaggerating a bit, which is very unlike you.

  20. 20 Frank Restly June 7, 2016 at 12:21 am

    “Frank, Are you aware of any country that imposes taxes on the interest paid to non-resident foreigners holding its bonds?”

    Nope, and actually I was proposing a property tax (tax on bond holdings) not an income tax (tax on interest payments received).

    In that way, the taxation becomes avoidable for non-residents by simply finding a U. S. domestic buyer for those bonds and your point:

    “How does this candidate suppose that these allies can simultaneously increase their dollar payments to the US without either exporting more to, or importing less from, the US?”

    Becomes mute. These allies can either return their bonds to the U. S. in the form of taxation or find a U. S. buyer for those bonds.

  21. 21 wiretap June 7, 2016 at 5:25 am

    If the problem is not enough saving, a tax on foreign bondholders would have the double benefit of increasing the incentive for domestic saving as yields rise.
    The concurrent impact of a selloff by foreign bondholders through the current account was explored by Michael Pettis in his 2011 essay “Foreign Capital, Go Home!”. By his logic, there are also positive through that channel.
    It seems a bit disingenuous to call accumulation of dollar assets by foreign states “manipulation.” The United States has actively promoted the accumulation and is at least as responsible for any negative effects as any foreign actor. The government enjoys the freedom of action it provides so much that policymakers are concerned with the most minute details of defending it, for instance when Congress held hearings about whether the Euro would erode the dollar’s share of mattress cash. A classic case of mistaking the health of the government’s finances for the health of the nation’s.
    Although anyone who hasn’t completely bought the “perpetual deficits don’t matter” story is a half-step ahead of mainstream thought, if they don’t grasp the direct relationship between the increasing health of the public purse and the declining health of the private sector they are likely to continue to pursue policies that damage the country’s trade position. I imagine that someone whose life revolves around strong balance sheets would find that freedom of action especially seductive.

  22. 22 Jerry Brown June 7, 2016 at 5:55 pm

    Thanks for the reply Dr. Glasner. But if the ceteris paribus assumption does not hold for 35 straight years, what is the value in assuming that it might in the first place? When do you start to think the underlying theory may not describe what is happening? 50 years?

  23. 23 David Glasner June 7, 2016 at 6:58 pm

    Jerry, The ceteris paribus assumption never holds; it is a thought experiment that tests whether a certain line of reasoning makes sense. I used the ceteris paribus assumption to test whether an argument that reducing imports into the US made sense. The assumption showed that, unless something else is going on, reducing imports will also reduce exports. But if enough other stuff also happens it is possible that reducing imports may wind up not reducing exports. The world is complicated, and it takes sophisticated empirical techniques to tease out those relationships from the data. Sometimes the statistical techniques work, and sometimes they don’t. But to answer your question directly, I don’t see what theoretical argument compels us to say that the exchange rate must adjust to bring the trade deficit into balance.

  24. 24 Jerry Brown June 7, 2016 at 9:11 pm

    Thank you again for the thoughtful replies. This is something I have been trying to understand for a very long time, pretty much since the time of the Plaza Accords about 30 years ago, which ,well, didn’t have the effects that I thought they were going to have. Since then all I have managed to come up with is that exchange rate movements in the U.S. dollar do not seem to effect the U.S. balance of trade all that much. So I continue to wonder why that is, and ask for help explaining my observation, whether true or false, whenever I can.

  25. 25 Frank Restly June 8, 2016 at 8:15 pm

    Jerry,

    “Since then all I have managed to come up with is that exchange rate movements in the U.S. dollar do not seem to effect the U.S. balance of trade all that much.”

    Because just as U. S. durable / non-durable goods become less expensive with a weaker dollar, so do U. S. domestic stocks, bonds, land, buildings, etc.

    To rectify trade balance, manufactured durable / non-durable goods must become less expensive for overseas buyers while capital goods must remain unchanged in price or become more expensive for overseas buyers. Currency depreciation / manipulation alone does not get you there.

  26. 26 Benjamin Cole June 8, 2016 at 11:55 pm

    One aspect of free trade politely never discussed: If a nation runs chronic trade deficits, it must either sell assets or issue mounting IOUs.

    Australia has run chronic trade deficits with Asia.

    Now see this:

    “Last week Westpac Bank decided to ban loans to non-residents, becoming the third major bank to do so after ANZ and Commonwealth. In an explanatory email to mortgage brokers it said its core objective was to help Australians realize their dreams of owning a home.

    Foreign property buyers received another blow late last month when Victoria raised a tax on foreign property purchases from 3% to 7% in its state budget. It also tripled the surcharge on ‘absentee landholders’ to 1.5 per cent from 0.5 per cent.”

    –30–

    Aussies say they are being priced out of housing markets by foreigners.

    Of course, the solution is probably to unzone property and build more housing. But like I always say, in the real world there are structural impediments and institutional imperfections.

    Should someone had told the Aussies, “Sure, you can borrow and spend and run chronic trade deficits. Your carefully cultivated neighborhoods, the most prime ones, will become foreign enclaves. You can fight this by bringing in the bulldozers and building more housing.”

    Free trade is a powerful theory.

    But people think nationally. Grow up in neighborhoods, surrounded by other people of the same nationality. We are taught to be patriotic. Defend our nation. Love our traditions, customs, culture.

    And sell our nation to foreigners?

    And can a nation perpetually borrow and spend its way to prosperity? Or is there a comeuppance? Are Aussies facing that comeuppance?

  27. 27 Jerry Brown June 9, 2016 at 7:11 am

    Frank Restly, that’s a good point that I was missing. Thanks.

  28. 28 Henry June 9, 2016 at 2:26 pm

    Benjamin Cole wrote:

    “Are Aussies facing that comeuppance?”

    There’s a lot that can be said about your comments, and a lot it goes to the heart of the “benefits” of free trade.

    Australia has always benefited from its vast mineral and agricultural resources. However, the realization of the potential of these resources has required heavy foreign capital investment. And while Australia is a large low value primary produce exporter, it is a big importer of high value manufactured goods such as vehicles and consumer electronics. Inevitably the trade balance goes against it. This has been offset by capital inflows which supported the development of Australia’s resource industry. How the overall balance looks at a particular time depends on where the investment cycle is relative to the cycle in commodity prices. Australia is also a strong exporter of tertiary services such as education and tourism, mainly to Asia. The problem is the Australian economy has been hollowed out by manufacturing industry destroying tariff reductions, reductions made progressively over several decades. Australia used to have an electronics, paper and textile industry. Now, It is about to loose the vestiges of its vehicle manufacturing industry. Given this industry’s links back into the broader manufacturing industry, this will have severe employment implications.

    On the other hand, Australians have enjoyed a greater range and quality of cheaper goods. How does one measure the net benefits?

    In the last few years, there has been a welter of Chinese investment in residential property and more lately in large tracts of agricultural land. Australia’s property market is booming, like many others. It would be well argued that this Chinese investment has little to do with the economic attractions of Australia and more to do with the vast amounts of Chinese capital fleeing China for a range of reasons. This is an important aberration, but has little to do with economic factors.

    The new trade agreement with China is also impacting directly on the Australian labour market. Chinese workers are allowed to enter the country, supposedly under the excuse that they relieve shortages of skilled labour. These workers work long hours for a small fraction of pay compared to local labour. Other workers have been allowed to enter the country under special visa arrangements for some years on the basis of local skill shortages. All they serve to do is drive down local pay and conditions and take job opportunities from trained Australia workers (mainly youth).

    Free trade isn’t that free. International capital mobility has issues for economic sovereignty and eventually for political sovereignty.

    The doctrine of comparative advantage (based on the assumption of full employment) is hardly sustainable.

  29. 29 Benjamin Cole June 9, 2016 at 8:37 pm

    Henry- (And David Glasner)

    Egads, Australia is doing the US thing.

    The free traders are too glib by half. How can anyone read your comment and say, “Yahoo, free trade just makes everything better.” ?

    Not for the average Aussie, it appears.

    Here is another query:

    Okay, in 1960, Detroit was the richest city (per capita) in the US. Why? It exported automobiles, and money poured like Niagara into the city.

    For whatever reason—unions, welfare, taxes, foreign competition—auto-making left Detroit. It became one of the poorest cities in the USA.

    Okay, suppose Detroit was a nation The free traders might say everything is dandy, after all they can import automobiles. Now Detroiters can concentrate on making sandwiches for each other.

    The problem is, exporting means income. Detroit is poorer for not exporting automobiles, and that is obvious.

    Add on: In a way, even the glib get this. When the Texas-North Dakota oil patches boomed (supplanting imported oil) everyone raved about all the jobs created, the labor shortages, the good times, the industrious free enterprise. No one said, “You know, this is actually bad. Instead of cheap foreign oil and higher living standards, now we have to employ people in the USA to produce oil.”

    Ditto on Silicon Valley. Forever we are told that “Silicon Valley must import cheap labor, or else the industry will go offshore.”

    Well, what is wrong with offshoring production to China and design to India? Then we don’t have to do anything! Just print money and buy gadgets. And the trade deficit is not a worry. So it gets bigger and bigger. So what? The capital accounts are in balance. Or so we are told.

    The free trade issue has been radically simplified by the glib. The fact on the ground are complicated, as they usually are.

  30. 30 Henry June 10, 2016 at 7:19 pm

    “Egads, Australia is doing the US thing.”

    Almost. Australians haven’t gotten too much past skepticism yet and beyond into expressing anger the way that’s plain in the USA. The Australian economic and social system is not as brutal as that in the US, but the conservative elites are working on it.

  31. 31 kaleberg July 5, 2016 at 10:15 pm

    This is a macro approach that ignores the realities of locality. The way a place, a city, a state, a nation, becomes a place is by replacing imported products with locally created products. That’s simple anthropology. If economies didn’t involve humans, the macro approach would be worth taking seriously. If you look at every developed nation on this planet, it developed by replacing imports, usually by limiting imports and developing local alternatives. I gather that there are satellites orbiting our planet looking for planets where this is not so, but none have been discovered as yet.

    P.S. The argument here seems to be that if the US should not worry about a trade deficit since it allows so many other nations to repay the money they borrowed from us. Unfortunately, the US has borrowed more from elsewhere than it has lent. Does that argument still apply?


  1. 1 “Nothing can be more absurd than this whole doctrine of the balance of trade”…. | Mostly Economics Trackback on June 2, 2016 at 8:33 pm
  2. 2 David Glasner on the Absurdity of Worrying About Trade Deficits - Cafe Hayek Trackback on June 17, 2016 at 10:08 am
  3. 3 The Absurdity of Worrying about Trade DeficitsWestern Free Press | Western Free Press Trackback on July 16, 2016 at 7:40 am
  4. 4 We often hear about the horrors of trade deficits, but what are they and are they all that bad? | Palm Beach Free Press Trackback on July 16, 2016 at 10:22 am
  5. 5 How Liberalism in America Became Synonymous with its Antithesis | Uneasy Money Trackback on July 31, 2016 at 10:20 pm

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About Me

David Glasner
Washington, DC

I am an economist in the Washington DC area. My research and writing has been mostly on monetary economics and policy and the history of economics. In my book Free Banking and Monetary Reform, I argued for a non-Monetarist non-Keynesian approach to monetary policy, based on a theory of a competitive supply of money. Over the years, I have become increasingly impressed by the similarities between my approach and that of R. G. Hawtrey and hope to bring Hawtrey's unduly neglected contributions to the attention of a wider audience.

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