Thursday, August 8, 2013

Stop Hatin' on the Trade Deficit (aka: America, Heck* Yeah!)

Conventional wisdom seems to always be a little loopy when it comes to international financial activity, including the trade deficit.  If we think of the trade deficit as an effect and not a cause, here is what it looks like to me:

Series greater than zero are inflows of dollars into the US and series less than zero are outflows of dollars out of the US.

The purple line reflects a persistent outflow of money from the US, mostly in the form of private flows, such as remittances, foreign aid, etc.

The red line is the net income on foreign assets.  This amount is persistently positive.   In other words, Americans consistently earn more from our foreign investments than foreigners earn on their American investments.

Now, here's the real knee slapper.  The green line is net new international investment.  Since this is always positive, this means that foreigners are always investing more money into the US than we are investing abroad.  Where do they get this money?  Well, the only flow left is imports and exports.  They have to sell us stuff in order to fund their new investments.

The conventional wisdom keeps up this far, and here, the story goes, we are selling ourselves into hock in order to buy junk from the Chinese.  But, you see the problem with that story, right?  Even after trillions of dollars of investments into the US, foreigners still can't manage to out earn us.  So, based on historic cost, foreign investments in the US are much higher than US investments abroad.  But, who cares about historic cost?  The market value of US investments abroad is larger than foreign investments in the US, and the net value is growing.  How can I tell?  Because we always have positive net income from net foreign investments.

How can this be?  If I may, it's because Americans kick ass!

Americans are the world's risk takers, and we do it well.   Our foreign investments are more private and more equity based than are foreign investments in the US.  We have filled two needs for the world.  First, we are providing a large amount of at-risk capital that the developing world desperately needs, and we are being compensated handsomely for it.  On the other hand, the US government has managed to create trillions of dollars of a "risk free asset", in the form of treasury debt, for sale to a risk averse world.

As long as these factors remain in play - and I don't see any reason to expect them to change soon - the idea that we have to get rid of the trade deficit to be sustainable is 180 degrees wrong.  At current levels, the playing field is tilted IN OUR FAVOR.  Our net income has grown tremendously.  It would take a trade deficit of more than $200 billion quarterly just for everyone else to be treading water relative to us.

America, Heck* Yeah!

(* edited for propriety at wife's request.)



    Do you want to comment on how your post differs from the 2006 paper on Dark Matter by Ricardo Hausmann and Frederico Sturzenegger, see:

  2. I guess I wasn't the first to come up with the idea. I suppose I should post less & read more. ;-)
    Thanks for the link.

    1. No problem KE! Anyway when the Dark Matter paper came out, I thought it was pretty clever, but for some reason it never caught on...maybe they/you are right after all?