Monday, August 15, 2011

Confusion About Trade Deficits

The blogger Cynicus Economicus has a new post here:
“A Ramble towards a Conclusion,” Cynicus Economicus, August 13, 2011.
In this post one finds a curious statement about the nature of trade deficits:
“And then there is the West. We have the infrastructure. We have opportunities and systems that have allowed us to have lifestyles that this emerging labour could only dream about. However, it was not enough for us. We wanted more, and more and more. We voted in governments that told us that we could have more and who borrowed in our names, and we borrowed to support our lifestyles, all the time thinking that it was our ‘right’ to enjoy our huge share of the world’s resources. Well, it is time for the West to wake up, and accept that the game has changed. What excuse was there for countries with fully developed infrastructure to borrow money, or why did so many individuals borrow so much when their wages might allow for a reasonably good life? It was borrowed because we wanted to consume more than we can produce.”
The post, and in particular this passage, demonstrates fundamental confusion about trade deficits: the author conflates a government budget deficit with a trade deficit.

Governments with monetary independence borrow in their own currency: they do not require foreigners to finance their deficits. When foreigners in fact purchase the newly issued bonds of another country it is because they have freely chosen to convert their foreign exchange for the local currency and purchase the bond. A great deal of government spending goes to purchasing domestic output, and even when money in a government deficit is used to buy an import, the financing of that purchase of a foreign good is a completely separate matter.

The blogger Cynicus Economicus complains that Western nations “consume more than we can produce,” a state of affairs that is allegedly an example of the West “living beyond its means.” What is conveniently ignored is the fact that the Eurozone* is the second largest Western economy (as well as the second largest in the world) and generally has trade surpluses:
Euro Area Trade Balance 2008–2011, Tradingeconomics.com
Moreover, any country that successfully runs a trade deficit is not “living beyond its means.” Such a nation paid for its imports because it attracted a capital account surplus to fund its current account deficit.

Foreigners freely and voluntarily bought the nation’s real and financial assets, and gave it the foreign exchange necessary to pay for imports. Even an individual is not “living beyond his means” if he sells, say, four of his 100 luxury cars to pay for additional consumption in one year, over and above his salary: he had the money to pay for his additional consumption by selling his assets. And, if he has a very large stock of many assets (both real and financial) which is constantly growing, he might be able to live like this for his whole life. Some nations (like Australia) have had virtually perpetual trade deficits through their history, but have no difficulty running them, precisely because they have a very large stock of real and financial assets, which is constantly growing, and these assets are bought by foreigners every year to fund trade deficits, even though the actual percentage of financial assets owned by foreigners each year might only fluctuate within the 15–30% range.

In short, the only time that a country is actually “living beyond its means” is when it has a balance of payments crisis, and the whole central argument of Cynicus Economicus collapses like a house of cards.

* The Eurozone consists of Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

3 comments:

  1. It's hard to defend , something like natural rights and by implication, someone as intolerant as Rothbard, but here goes-
    Lets start with Hume's really really bad is ought problem. Even Sam Harris attacks it as lazy nonsense http://www.intelligencesquared.com/events/sam-harris
    Every act of "if-then goal directed behavior every act of engineering is based on the premise that you can derive an ought from an is.

    I can almost hear the response: "How do you know that the goal directed behaviour is itself moral?" its a good question. First we can note that every ought and value is itself a species of fact. ("It is a fact that John Smith marching in 1963 believes that jim crow laws are wrong because they violate the human rights of black people.). Second every value and preference presupposes another assumption behind it, and another, and another, in a non-vicious infinite regress. (y -> y1->y2 etc,)
    There are trillions of possible variables out there, the ones that are the most fruitful and have the most powerful are the ones that are the most encompassing.
    For example, you believe in rule utilitarianism. Thats fine, I have no problem with it per se except that i think it is incomplete. I also think snobbish arrogant utilitarians like Jeremy Bentham were engaging in exercises of mass delusion and self-contradiction. For if happiness is the moral standard, and the rules which enhance the greatest amount of happiness for the greatest amount of people are the right rules doesn't that imply that people have a RIGHT to enjoy such happiness? where does this right come from i wonder? Could it be (gasp) nature?
    The second problem is the vagueness of such a happiness standard in the first place. utility and happiness is such a subjective concept, the clash of preferences is a real problem, whereas life and liberty is clearer and more, if not totally objective
    The third objection i have against utilitarianism is the problem of mob rule or majority tyranny. Utilitarianism offers a rather weak objection against the problem of a lynch mob against an innocent victim, it would not be in the best interests of the mob's "long term happiness" to inflict pain on an innocent victim. Natural rights on the hand, offer an enormously powerful and iron hard moral sentiment against majority tyranny. I have a right to live my life, stand alone and be happy, will of the majority be damned! People didnt sit in seg. restaurants for utility! They didnt fight the nazis for utility! they fought for their human rights!

    Let me stress that I'm not a rothbardian i'm more of neo-lockian, I favor natural rights, (although my natural rights is less like rothbard and more a rule consequentalism based on life and liberty rather than just utility,) social contract ethics, and utilitarianism. I believe in them all, I'm not close minded like some people.

    Oh and by the way, LA Rollins was a holocaust denier, really classy guy youve got there. His response to natural rights is a joke, natural rights are prescriptive not descriptive,
    Cheers
    Ed

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  2. Irrelevant, but heads up -

    Paul Krugman has made a post countering MMTers, saying that deficits financed by printing of money will lead to hyperinflation.

    Yes, he used the H-word, hyperinflation.

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  3. @Prateek Sanjay
    And Bill Mitchell has made a post answering Krugman's fears.
    http://bilbo.economicoutlook.net/blog/?p=15722

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