Budget Deficit's Real Consequence: The Trade Deficit
Budget deficits are not only about our childrens' future, interest payments, or "crowding out" of private business investment. As Paul Volcker puts it, budgetary deficits are "paid by" for a corresponding trade deficit, in effect subsidizing imports--and making American goods less competitive in domestic and world markets.
While unions, regulations and the like all combined to make America less competitive, there have always been business-friendly right-to-work states--where both labor costs and regulation are kept under control. Yet these states must increasingly waive taxes and subsidize businesses to attract the jobs their populations require.
Every foreign dollar that funds our deficit is a dollar that isn't buying our exports. It pushes up the value of the dollar, and the resulting inflow of capital often overshoots Congress's borrowing needs--providing the fuel behind every bubble in the past two decades.
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May '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
I question the idea that trade deficits are necessarily problematic (not that such a sentiment is expressed here). A trade deficit is a negative difference between the market value of the goods imported and exported by economic agents within a nation, where the market value the of total imports exceeds the market value of the total exports.
Exchanges in markets either are positive-sum exchanges (win-win) or tend towards positive-sum status. Importation and exportation are merely concepts associated with exchanges that are international in scope. When U.S. firms import goods, they expect to benefit from those goods (otherwise they wouldn't have proceeded with the exchange) and the same applies to U.S. firms that export goods. These are either positive-sum exchanges or, if not, they give information to the participants that enables them to avoid further non-beneficial exchanges.
The only way I can see our trade deficit as financing our budget deficit is if you argue that the money that our trade deficit commits to nations like China enables such nations to lend more money to our government. But this would be a government responsibility problem, not a trade deficit problem.
Oct '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
It is impossible to borrow abroad without running a trade deficit. Since the budget deficit is too large for our own domestic savings (even today), Congress must borrow abroad.
Massive foreign borrowing "crowds out" exports. The trade deficit isn't a private-sector phenomenon (before we started running massive deficits our current account fluctuated around -1/+1 percent of GDP, if I recall correctly).
There are only so many dollars traded in the FX market, and if many of them are going to finance Congress's deficit that leaves less for foreigners to pay for U.S. goods. Thus, the value of U.S. goods relative to the rest of the world goes up.
Oct '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
Think about it. If trade is perfectly balanced, there aren't any spare dollars for foreigners to loan--everything is going towards trade. Under a floating exchange regime, the massive capital inflow financing Congress's deficits pushes up the value of the dollar, creating a trade deficit large enough to finance the budget deficit.
BTW, this happens even if Congress is funded entirely through our own savings. If Congress eats up most national savings, the private sector will be forced to borrow abroad--creating the same effect.
This has nothing to do with private markets. It's a government responsibility problem, yes. That was my original point, or my intention at least.
Oct '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
Why is it no one seems to care about this? I was shocked when I discovered it; if Congress's borrowing makes American goods less competitive, how can politicians claim it's a good way to stimulate the economy? Many of them are aware of this; I've seen Paul Volcker explain this in several C-Span videos (one in 1982 and one in 1992--but a lot of those politicians are still around).
Feb '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
No kidding. I've often wondered about the link between the spending deficit and the trade deficit.
Of course there isn't a 1-to-1 correspondence-- we finance a lot of the trade deficit by the mere fact that our currency is the de-facto world currency, and other countries want our dollars just as much to be able to trade amongst themselves as they do to be able to trade with us (or buy our bonds). But that can go only so far-- once people start moving to other currencies, watch out for the backlash.
Also, reducing our spending deficit won't necessarily have an immediate effect on the trade deficit. All in all, though, everything will find its balance, even if it's chaotic in its path as it tries to approximate the balance. You can push one thing out of balance for a while, but it always throws something else out of balance too.
Feb '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
This is why the stimulus basically goosed China's economy, not our own.
Oct '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
I agree; our spending has stimulated foreign nations more then our own.
I don't expect a balanced budget to immediately affect the trade deficit. However, at least this makes it possible for our balance of trade to gradually fix itself.
Price signals are important, and the budget deficit is the mother of all price signal distortions.
May '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
This would mean something if the US and China were the only two countries on earth or if the US economy was 50% of global GDP. But trade deficits are not inherently problematic by themselves unless you are a manufactured goods exporter, or you believe that foreign investment in the US (AKA "capital inflows") is inherently bad.
On the other hand, chronic and growing current accounts deficits are a problem- not because of trade issues, but because of the liquidity trap associated with debt service. Trade deficit panic is simply a standard anti-free-trade AFL-CIO talking point.
Oct '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
What? Congress balancing the budget is anti-free-trade?
I'm not arguing for trade protectionism. In point of fact, I'm doing research in monetary best practices that promote free trade.
My point is Congress's budget deficit unfairly distorts free trade. We don't need to protect our own goods--the FX market will naturally lead to balanced trade, and balance trade naturally leads to greater prosperity.
But for that to work, we must stop distorting the capital account with such massive deficits.
Duane Oyen
This would mean something if the US and China were the only two countries on earth or if the US economy was 50% of global GDP. But trade deficits are not inherently problematic by themselves unless you are a manufactured goods exporter, or you believe that foreign investment in the US (AKA "capital inflows") is inherently bad.
On the other hand, chronic and growing current accounts deficits are a problem- not because of trade issues, but because of the liquidity trap associated with debt service. Trade deficit panic is simply a standard anti-free-trade AFL-CIO talking point. · Dec 2 at 2:37pm
Oct '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
Here's a link to an article I wrote on my blog. I guess I need to be more careful to avoid protectionist language; in my worldview, free trade is unfair because Congress distorts it, with the budget deficit the biggest distortion of all. Foreign nations sometimes use unfair practices, but they are moving away from that--the financial crisis gave them a jolt of what artificially unbalanced trade can do.
The problem aren't foreigners--who are being rather nice, in my opinion--it's Congress.
Re: Budget Deficit's Real Consequence: The Trade Deficit
My guess is that it's because a very well respected school of thought is that trade deficits are not inherently bad. Isn't that Milton Friedman's point here, from his speech to the National Association for Business Economics in 1989:
The trade deficit is a sign of American strength because its counterpart is a capital inflow. The japanese and other foreigners, as well as domestic residents, are investing in the United States because they can get a higher return here than they can elsewhere. Is that a sign of our weakness and their strength or is it the other way around? We have been able to have a higher level of investment than we otherwise could have had because of the capital inflow.
I understand you're not a protectionist (at least I think I do), and I am not trying to put words in your mouth, just trying to answer your question. I don't know if this answers it or not.
Edited on Dec 3, 2010 at 10:46amSep '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
It goes back farther than Friedman. It goes to David Ricardo. There is no more reason to fear our trade deficit with other countries than there is to fear one state's trade deficit with another state. The US govt spends money for good or ill and it borrows money in world capital markets. If foreign govts want to buy or not buy or bonds or our currency they are free to do so or not. We have had capital account surpluses for many years under many different interest rate and exchange rates because the United States is still a good place to invest in capital of all sorts...not as good as it once was perhaps but still quite good. I fear our spending because I think its ineffective and reduces our productivity. I don't think the trade deficit per se is involved.
May '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
Joseph Eagar: What? Congress balancing the budget is anti-free-trade?
Duane Oyen
This would mean something if the US and China were the only two countries on earth or if the US economy was 50% of global GDP. But trade deficits are not inherently problematic by themselves unless you are a manufactured goods exporter, or you believe that foreign investment in the US (AKA "capital inflows") is inherently bad.
On the other hand, chronic and growing current accounts deficits are a problem- not because of trade issues, but because of the liquidity trap associated with debt service. Trade deficit panic is simply a standard anti-free-trade AFL-CIO talking point. · Dec 2 at 2:37pm
Dec 2 at 2:59pm
Joseph, I am really curious to see how you read what I wrote and somehow got the highlighted statement out of it.
I personally would like it if we were more cost-competitive internationally (we also lose somewhat due to regulation, but union work rules tend to cause more of the problems), but trade deficits, as David points out, are widely misunderstood. For another view, read Don Boudreaux at Cafe Hayek.
Sep '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
3 cheers for Cafe Hayek and the gentlemen who produce it. also econtalk.org and library of economics and liberty
Dec '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
At the federal level there is no such thing as a real "budget deficit" on a cash basis. Cash coming in (from all sources) matches cash going out. David Ricardo also pointed out that taxpayers/bond holders are indifferent between sovereign taxation and sovereign borrowing. Sovereign borrowing is merely "contingent taxation" or a promise to levy a tax on someone at some point in time in the future to repay the nominal bond holder. A debate about a federal "budget deficit" is primarily a debate about wealth distribution: that is will the government pay nominal bond holders by taxing others. Or will the government turn the "contingent tax" status of government bonds into actual tax status by deciding that the bond holding class is the group most able to carry the burden when the government chooses to uses current taxes instead of bonds to carry the cash flow burden. The only real point at issue is this: should we tax wealthy bond holders (or more crudely "default" as they call it) or should be tax the working poor and middle class to repay bonds held by rich people.
Dec '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
Likewise there is no trade deficit issue, but merely a failure to draft regulations so that they capture the true regulatory intent. For instance, labor and environmental regulations for the most part are written to control things that happen at places. For example, EPA rules govern point source pollution, not the pollution produced attendant to the manufacture of things. That is the rules say things like: power plants burning coal in state "x" may not pollute. The regulations do not say that "widgets may not be put into the stream of commerce unless they come from clean manufacturing sources." We have a trade deficit today only because we allow manufacturers to escape regulation costs by moving their dirty operations to places outside the scope of regulations. If the regulations were directed at things put into the stream of commerce, then goods made in Mexico would be subject to the same rules as goods made in Ohio if both were sold in commerce in the US. Thus, the trade deficit reflects merely the avoided cost of regulatory compliance. The rules should be redrawn to stop that.
May '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
Harry, how do we monitor how those goods are created? Does the manufacturer have the burden, and how would he prove it? I agree with you that we should draft the regulations to better do their jobs, I just don't know how enforcement would work without some sort of international agency framework. While this sort of enforcement wouldn't intend to add any costs outside what we have domestically, I think it inevitably would, leading to a trade-quashing effect.
Oct '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
You're missing my point.
Budget deficits drive trade deficits. Government deficit spending has always appreciated the real exchange rate, whether through inflation (under the Gold Standard) or the fx market (today). You cannot argue Treasury bonds are real investments. How much of the deficit is actually invested in productive activity? Is any of it?
Trade deficits are not a bad thing, so long as government budgets are balanced. If that isn't the case, trade imbalances (in general, not just deficits) become economic death spirals, dividing the world into hyper-consumers and hyper-savers.
Oct '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
And to the idiot Ricardian, keep in mind there are only so many goods and services in the economy, regardless of who has what amount of money. This is why deficit spending creates trade deficits, btw.
And to the person whining about regulation, keep in mind that poor people in nations like China would still be starving without foreign direct investment; whether or not its ethical depends more on income growth then total income (again: only so many goods and services to go around).
Also, federal borrowing isn't postponed taxation; by subsidizing imports, it's taxing exporters today.
Oct '10
Re: Budget Deficit's Real Consequence: The Trade Deficit
David Limbaugh
My guess is that it's because a very well respected school of thought is that trade deficits are not inherently bad. Isn't that Milton Friedman's point here, from his speech to the National Association for Business Economics in 1989:
Edited on Dec 03 at 10:46 am
Yeah but if most is going in government debt, you end up with horrible spirals, and a great deal of mal-investment. And a declining savings rate, apparently. Why is the Fed monetizing the deficit? They hate Congress. Their trying to reduce current account pressure.
A "natural" trade deficit will inevitably be paid off by a surplus--at least in theory. Private people do have to pay their debts eventually, you know, and that implies a surplus at some point in the future.
I'm amazed how well the gold standard worked, when nations were truly committed to it--balanced public budgets, a commitment to balanced living by private entities, etc.
Edited on Dec 12, 2010 at 1:21am