The Trade Deficit, another view
- From: William F Hummel <wfhummel@xxxxxxxxxxx>
- Date: Tue, 11 Oct 2005 09:21:25 -0700
?Sharecropper?s Society? Revisited
by Thomas E Nugent
August 16, 2005
Are we selling out to foreigners, as the Washington Post suggests?
Recently, one of the directors of the Washington Post, Warren Buffett,
said that the U.S. was on its way to becoming a ?sharecropper?s
society.? The statement characterizes the Washington Post?s latest
economic theory on international trade. In a recent editorial entitled
?A Sharecropper?s Society?? the Post bemoans America?s sacrifice of
future standards of living for current consumption by selling out to
foreigners:
"Every year Americans sell or mortgage a slice of their productive
assets to foreigners with the result that income from those assets
must flow abroad in the future."
Does the Post?s economic position make any sense? Let?s investigate.
When Americans sell a piece of their productive assets, they receive
an agreed upon payment in return. This is a voluntary transaction at
the ?market? price, which means the buyer and seller are both
satisfied with the price. This price should reflect the present value
of all expected future cash flows of the productive asset that is
sold. The seller also has the cash resources that can be used to
purchase foreign productive assets, build U.S.-based productive
assets, or simply be saved.
If a loan funded a buyer?s purchase, the loan also ?creates? an
equivalent deposit. The transaction means that the loan itself creates
the funds that buy the productive assets. The funds do not come from
some mythical ?pool of savings,? as described in the ?loanable funds?
rhetoric freely tossed around by the media and others who should know
better. It?s a zero-sum game, in the sense that loan/deposit expansion
does not create any net financial assets. However, the economic
activity created by the purchase of goods and services and related
loan creation increases output and income so that the economy grows
accordingly.
More, the Post?s idea that income ?flows? abroad is not what happens.
Let?s go back to the April 10, 1984, edition of the Wall Street
Journal. Leif Olsen, the chairman of Citibank?s economic policy
committee, made the following important distinction in a letter to the
editors:
"If you hear 'import,' what immediately comes to mind? You?ll
probably say 'cars.' Now, if you hear 'capital flow,' what do you
think? Money coming in, right? Wrong. Money doesn?t come in from
abroad like cars. It?s already here."
In other words, money doesn?t flow offshore. Rather, domestic claims
change hands. Many economic commentators miss the fact that when the
U.S. went off the gold standard in 1971, there was no longer any
guarantee behind the U.S. dollar ? it became a fiat currency. As such,
there was no gold being moved around in the basement of the Federal
Reserve Bank of New York to settle liabilities to foreigners. Foreign
holdings of U.S. assets, namely Treasury bills, must be redeemed some
day but can only be redeemed for U.S. dollars and spent or ?saved? as
U.S.-dollar financial assets. Foreigners can trade U.S. government
liabilities, but in the end, the ?buck? stops here.
To some extent, we are ?mortgaging? our future, but the transaction
whereby we consume their resources now and they consume our resources
later is a game that is stacked against foreigners since our policies
are the ones that set future domestic prices, export taxes, and
restrictions. In other words, we can decide to reduce the future
purchasing power of foreigners via the multitude of legal policy
options at hand.
Equal trade, whereby we consume foreign labor (a.k.a., creating jobs
abroad) by buying their goods in exchange for U.S. financial assets
that allow foreigners to buy our goods in the future, can provide the
flexibility for each trading partner to time purchases of goods and
services. For example, Japan has been accumulating net U.S. financial
assets for decades and not net spending. For all practical purposes
the Japanese are satisfied with the U.S. consuming their physical
resources in exchange for their accumulation of U.S. financial assets
indefinitely. And, as previously noted, we have perfectly legal policy
options to unilaterally minimize the value of their holdings of U.S.
financial assets should we so decide.
What are the Post?s editors attempting to do? Are they implying that
selling now is bad and that not selling is good? As I mentioned, the
total transaction ? buying now with I.O.U.?s given to sellers for
their future buying ? works entirely to our advantage. What is
important is that the transaction takes place: Domestic credit creates
the loans and deposits (there is no such thing as ?imported capital?),
we get the goods and services, foreign investors are paid for their
output with the newly created deposits, and non-resident savings are
created for possible future spending.
The U.S. population benefits, without a sharecropper among us.
? Thomas E. Nugent is executive vice president and chief investment
officer of PlanMember Advisors, Inc. and principal of Victoria Capital
Management, Inc.
.
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