Where's the Debt?
I still get a lot of email and
commentary on my posts explaining why a trade deficit does not
necessarily result in a build up of debt. Its a mistake that
protectionists like Lou Dobbs make, either accidentally or on
purpose, to confuse the trade deficit with a debt (Dobbs, in the linked article, claimed that we had $5 Trillion in accumulated trade debt). In another
attempt to explain this, I want to present a thought experiment.
In our hypothetical, a regular old
American guy named Joe walks into a Wal-Mart to buy new Plasma TV.
Lets assume that Joe is presented with two choices, a Chinese-made TV
and an American-made TV. The American TV is $2000 and carries a
brand Joe recognizes; the Chinese TV is $1800 and is a brand Joe
does not recognize. As far as he can tell, both are featured
similarly.
Joe may choose to take a chance with an
unknown brand to save $200, or he may not. Let's see what happens
either way. If Joe picks the Chinese TV over the American TV, the US
trade deficit will likely be worse, by whatever Wal-Mart has to pay
to restock the shelves. But, while the trade deficit may be worse if
Joe buys Chinese, is there any additional debt created by buying
Chinese rather than American?
Well, Joe doesn't have more or less
personal debt either way. Whether he is paying with cash or
financing the TV, this decision is unaffected by whether he buys
Chinese or American. He may happen to buy Chinese and take on debt
to purchase the TV, but the decision to take on debt has nothing to
do with the fact that it is an import. If he had bought the American
TV, he presumably would have taken on debt for that purchase as well.
In fact, if anything, since the Chinese TV is cheaper, Joe's
personal debt is reduced by buying Chinese over American.
In fact, the only way in which Joe's
personal debt could be said to be increased by Chinese imports is if
the $200 price differential was enough to change his mind from
not-buying a TV to buying one, and he then financed the purchase.
But this is only going to occur in a small percentage of
transactions, and besides, it would be unfair to call something so
empowering "“ ie giving Joe the power to get something he really
wants that he would otherwise been unable to "“ as a negative.
(Update: I do think this is sortof the logic trade opponents
use. They argue that "rampant consumerism"is causing an increase
in consumer debt which is kindof sortof tied up in some way with this
whole cheap Chinese goods at Wal-Mart thing, so therefore trade
causes debt. This may sound good rhetorically at an
anti-globalization rally but makes no sense scientifically).
Now let's take Wal-mart. Assuming they
know how to price items, they will make a gross margin on either the
Chinese or the American TV. How, then, can having to restock the TV
Joe bought by buying one from an American factory for say $1400
affect Wal-Mart any differently than paying the same (or less) money
to a Chinese company? The answer is that it has no effect. Buying
Chinese vs. American has no effect on Wal-Mart's debt.
So let's say Joe bought the Chinese TV,
and the Chinese end up with $1400 (the factory price) in US currency
courtesy of Wal-Mart. If they don't need anything in the US, they
will trade this currency for yuan to someone in China who does want
to buy something in the US. Let's assume that these dollars are all
incremental, so none go to buying exports from the US or goods to be
consumed in the US. Let's assume that it all gets invested as
profits, and further, let's assume that it gets invested 100% in US
debt securities.
Aha! People want to say to me. There
is the debt! Chinese are buying up US bonds. And so they are. But
trade did not cause or create the debt. Just because Chinese trade
dollars are reinvested in debt securities does not mean trade cause
the debt. In fact, the US government debt would exist with or
without Chinese trade, courtesy of the tax and spend whores of both
parties in the US Congress. If the Chinese had not bought the debt,
someone else would have, and the debt still would have existed. In
fact, the US debt would likely have just been a bit larger and a bit
costlier without Chinese buyers to bring down interest rates.
So, to review, an average American
makes an incremental decision to buy Chinese rather than American,
the trade deficit gets worse, but no debt is created. So I renew my
challenge to Lou Dobbs, who claims America has $5 trillion in trade
debt by asking a simple question: Where?
Max:
I think a different argument is, that the trade deficit is an indicator of whether wealth and money is pouring in the country or out of it. As stupid as this notion is, it is exactly the nationalist argument many of those fearmongers use. They say that with a trade deficit of 5 trillion doller, doesn't necessarily mean a "debt", but rather a transaction of wealth from the US to all the foreign nations who make business here.
December 3, 2006, 9:46 amThe problem with this argument is that it is simplistic and easily understandable if you at least know a minimum about math. This is the reason why this argument is also an appealing one and a strong one, which has to be refuted.
lk1:
The trade deficit and the national debt are different. The U.S. problem is that the national debt, the borrowing of money from someone (mostly US citizens in the past and now a great deal from China, Japan, and Europe) by selling promissory notes (US Treasuries etc) continues to increase and is involuntarily accumulating debt on each citizen of the US. Both the interest and the principal must be repaid at some point and as long as the debt increases due to excess spending by the government(borrowing more than it makes), our US standard of living must eventually decline (not accounting for technology). Inflation may allow the US to repay part of the debt with cheaper dollars but that has another subset of problems. Continued increased national debt will eventually cause increased taxes (decreased standard of living), a decreased value of the dollar ie inflation (decreased standard of living, or even failure of the government (decreased standard of living). Essentially the government, like each of it's citizens, must eventually live within its means or suffer the consequences. This, I believe is the primary problem, and since the majority of our government borrowing is from the Chinese, many people confuse the borrowing (borrowing is BAD) with the purchasing of less expensive Chinese materials (which is GOOD). Obviously with the globalization of goods/services and consequent competition, prices (and therefore salaries/jobs primarily American salaries/jobs) are going to decrease as Chinese jobs/salaries increase unless the U.S. replaces those jobs with some service or product in which the U.S. has a comparative advantage over the Chinese (or whichever country). Fortunately the US dollar has become the gold standard and therefore the US can continue to borrow temporarily although eventually with increasing debt the dollar will fail. Harry Reid, the new House whip appears to understand this problem-hopefully he will lead some action to accomplish the appropriate objectives. Many others in our government appear to be completely unaware of the situation. Finally in an only partially related discussion, my own personal objection to the IRAQ conflict is that we are financing the conflict with this borrowed money. If the US had tons of surplus money not needed for alternative fuel research, health, seniors, poverty, education, etc., helping others might not be so reprehensible (not to mention the Americans lives lost).
December 3, 2006, 4:42 pmRay G:
Nice examples. I've always found it works best in comparing the individual to the overall economy. Most people just don't seem to get econ, and so breaking it down to our personal choices tends to work best. As in, I give Wal-Mart money, they give me goods - what deficit? That's a little over simplified, but it makes the point.
December 3, 2006, 8:29 pmBlacquesJacquesShellacques:
More importantly, lets talk about power.
Joe, an American, has the TV, a nice hard asset.
The Chinese have some greenbacks. That is they have Joe's promise to give the Chinese something worth the same as the TV, someday, on demand, if all goes well, etc. etc (add more lawyers double talk and escape clauses)
I myself do not trust Joe worth nothin'. He is notoriously unreliable, a drunk, a drug user, he could go bankrupt anytime. Imagine, he voted Democrat. What an idiot is Joe. Even so he talked so-called clever Chinaman out of a TV.
Stupid Chinee, tricked by fast talking Yankee into trading valuable TV for mere paper.
December 3, 2006, 8:33 pmAldo54:
There is no such thing as a trade deficit - it is the biggest made up problem ever.
December 4, 2006, 9:31 amPeter Duray-Bito:
Joe is borrowing money from China to buy the Chinese TV. China will keeping lending Joe money as long as Joe keeps buying China's new TVs. This has been a nice arrangement for the past 20 years or so.
If Joe, for whatever reason, finds he can't borrow from China anymore, China will want to get something from Joe in exchange for the IOUs it holds. China, naturally, will want some of Joe's stuff. But by then, most of Joe's TVs are busted and Joe will have to fork over his primary asset: land.
Naturally, Joe will just tell the Chinese to come and get it. For now, Joe's defense forces still rule the skies. But will that still be the case when Joe can't borrow anymore?
December 4, 2006, 4:16 pmChris:
Peter - Joe isn't borrowing from China to buy the TVs - thats the whole point, there is no debt. Joe gets a TV, China gets an appropriate amount of currency.
December 4, 2006, 6:18 pmPeter Duray-Bito:
Chris, Joe's money for the TV comes from the money he's borrowed against his home. This money comes from Treasuries our government sells to the Chinese. The Chinese claim against the U.S. bonds they own ultimately is Joe's house.
Reality check.
December 4, 2006, 7:22 pmUltima Ratio:
You'll be pleased to know that your website is the 2nd Google result for "Lou Dobbs trade deficit" (a simpering Mother Jones interview being the first).
December 5, 2006, 11:01 amBill:
Wow. The second sentence of the post states that, "It's a mistake... to confuse the trade deficit with a debt," the second commenter expands on this point, and Peter still manages to screw it up.
December 5, 2006, 1:41 pmBlacquesJacquesShellacques:
A comedy in three steps:
Chiang Kai Shek: Joe, I'm the Chinese repo man come to get your TV or seize your land.
Joe: (After 3-5 years of legal wrangling, seizure exemptions, bankruptcy, stays of execution, appeals, relief from forfeiture etc etc) OK, go ahead, take the land, here's the deed.
State and Federal Tax Assessors: Chiang, did we mention non-resident taxes? And all the tax arrears? Yes they're both very high. We need the money to look after Joe.
I used to practice law in Canada. I have tried to seize assets, including land, from American debtors. Ha. Ha. What fun.
The absolute and only thing the Chinese can do with the money is "Buy American". Or burn it, I suppose.
Every lawyer knows that when debt reaches a certain level your banker becomes your partner.
Howdy partner, Chiang.
December 5, 2006, 8:08 pm