Coyote Blog

The Anti-Planner has more on the California high speed rail proposal I wrote about earlier.  My guess was that the first $9 billion bond issue, on the ballot this fall, would not get the train out of the LA metro area.  Well, I was right and wrong.  The smart money thinks the line will start at the other end, in San Francisco.  But the betting is that for $9 billion the line won't even get out of the San Francisco metro area, making it perhaps as far as San Jose. 

But we have a second data point -- there is a proposal on the table to extend BART from Fremont to Santa Clara for $4.7 billion, a distance (as shown on the map below) about a third of that from San Francisco to San Jose.

I am not sure what high-speed rail technology that they are considering, but a true high-speed line requires special alignments, track, and signaling that should make it FAR more expensive per mile than a BART line (just as an example, a true high-speed line could take miles to make a 90 degree turn, eating up land and reducing alignment flexibility in a very congested and hilly area).  And remember, the BART cost estimate is probably low.

No way these guys get to San Jose for $9 billion, much less to LA for $40 billion.  Just what Californians need with their massive budget deficit:  a brand new white elephant.

JD Tuccille has a roundup on the state boondoggle that won't die, the proposed 3/4 of a Billion dollar state subsidy for an amusement park. 

Now, this seems like an awful lot for an amusement park, particularly considering that the Arizona desert has been the death of many theme parks.  The reason is that no one wants to be outside for extended periods of time in June-Sept in the Phoenix or Tucson areas.  Because it is freaking hot.  The average daily forecasts is generally for 108-112F for these summer months.  But theme parks live and die in the summer, when kids are out of school.  Even though they have milder weather and a large population base at Magic Mountain in LA, they still only open for weekends and holidays during the non-summer months.  My guess, from running a similar seasonal business, Magic Mountain loses money most of the year and make 100%+ of their profit in the summer.

So spending $750 million of taxpayer money on a theme park in the Arizona heat would be a bad idea if located in Phoenix.  But what happens when we put it in Eloy, Arizona?  Eloy is just as hot, but is in the middle of nowhere, as shown below at the point of the "A" balloon.

People will come here, from where?  Tucson folks in the summer will want to go someplace even hotter than Tucson?  Phoenix folks will want to drive 2 hours to spend their time in the hot sun, when the same distance north puts them in the cool mountains?  And here is beautiful downtown Eloy, brimming with wealth enough to repay over a billion dollars of principal and interest.

This project is absolutely guanteed to fail, leaving the bill with taxpayers.  I mean, seriously.  Never have I seen such a lock.  I wish there was a way to short this.

This is only the most eggregious of a laundry list of proposed government pork being pushed under the banner of "job creation" at a time when the state budget is over a billion dollars in deficit.

I had occasion to think about the term "public service" at about 6AM this Sunday morning.  As I was driving my son to a way-too-early baseball game, I flipped around the FM dial trying to find some music.  There was none.  All I could find were a number of really dull programs on arcane topics presumably on the air to fulfill the radio broadcaster's "public service" requirements of the FCC regulatory regime.  Since almost no one gets excited about this programming except for the leftish public policy types that inhabit regulatory positions, the radio stations broadcast all this garbage on Sunday mornings when no one is listening anyway.  Ironically, in the name of "public service," stations must broadcast material no one in the public actually wants to listen to.

Which leads me to coyote's definition of corporate public service:  Make a product or service for which people, without use of force or fraud, are willing to pay the listed price.

Any freaking moron can (or at least should be able to) offer a product or service that people will be willing to use for free.  Is this a public service?  Well, maybe.  If you are out there helping to feed homeless people, power to you.  But is it really a public service that the Miami transit system offers free rides that it can only pay for with deficit spending?  Or $1.50 bus rides that cost taxpayers $30 each to provide?  And this is not to mention the free services, like public service radio broadcasts, that many people would be willing to pay not to receive. 

That's why I say that any moron can give stuff away.   But find me the person who can create enough value that people are willing to pay enough for his product to cover all the material, labor, and capital inputs it took to create it, with surplus left over for both buyer and seller, and that is the person performing a real public service.

And let me listen to some freaking classic rock on Sunday mornings.

In a previous post, I observed that there did indeed seem to be two Americas:  the one productive people want to live in, and the one productive people are trying to escape because the local government is so controlling and confiscatory.  I further observed that, unfortunately, both Democratic candidates appeared to be from the latter.

This is an interesting follow-up:

"When California faced a Mount Everest-sized $14 billion deficit in
2003, one of the major causes for the red ink was the stampede of
millionaire households from the state," says a report called "Rich
States, Poor States" by economists Arthur Laffer and Stephen Moore.
"Out of the 25,000 or so seven-figure-income families, more than 5,000
left in the early 2000s, and the loss of their tax payments accounted
for about half the budget hole."

I am not sure how they got to this number, but holy crap!  20% of the wealthiest families left the state?  I'm not sure even Hugo Chavez is doing that poorly.

Update:  Even more here, comparing inward and outward migration rates of states vs. a state-by-state economic freedom index.

Letter I sent to Governor Schwartzenegger in response to his plan to close a number of California State Parks due to budget problems:

I know many people are
probably contacting you to oppose proposed closures of state parks to help meet
budget targets. My message is a bit
different: Closing these parks is
totally unnecessary. 

I own and manage one of the
larger concessionaires in the California State Park (CSP) system. We are the concessionaire at Clear Lake and Burney Falls. At Burney Falls, for example, we have invested over a million dollars
of our money in a public-private partnership with the state to revamp to the
park. We also operate parks for the
National Park Service, the US Forest Service, Arizona State Parks, Texas State Parks, and other public authorities.

Traditionally, CSP has
engaged concessionaires to run stores and marinas within parks, but not to run
entire parks. However, in many other
states, our company runs entire parks and campgrounds for other government
authorities, and does so to the highest quality standards. 

So, I can say with confidence
that many of the California State Parks proposed for closure would be entirely
viable as private concessions. For
example, we operate the store and marina at Clear Lake State Park but
could easily run the entire park and make money doing so, while also paying
rent to the state for the privilege.

I know that there are some
employees of the CSP system that oppose such arrangements with private
companies out of fears for their job security. But it would be a shame to close parks entirely when an opportunity
exists to keep them open to the public, and improve the state budget picture in
doing so. 

Even if California decides to keep these parks open, I would encourage
you to have your staff investigate the possibility of expanding private
operation of state parks. CSP already
has one of the best and most capable concession management programs in the
country, a success you should seek to build on. The infrastructure is already there in CSP to solicit bids for these
projects and ensure that management of them meets the state's quality and
customer service standards.

Even though everything I said here is true, it probably is a non-starter because most state organizations are dead set against such private management.  They would rather close services to the public than establish the precedent of private management. 

Besides, the whole parks closure may well be a bluff.  Unlike private company budget discussions, where it is expected that managers offer up their marginal projects for cuts, the public sector works just opposite:  Politicians propose their most popular areas of spending (parks, emergency services) for cuts in a game of chicken to try to avoid budget cuts altogether.  As I wrote here:

Imagine that you are in a budget meeting at your company.  You and a
number of other department heads have been called together to make
spending cuts due to a cyclical downturn in revenue.  In your
department, you have maybe 20 projects being worked on by 10 people,
all (both people and projects) of varying quality.   So the boss says
"We have to cut 5%, what can you do?"  What do you think her reaction
would be if you said "well, the first thing I would have to cut is my
best project and I would lay off the best employee in my department". 

If this response seems nuts to you, why do we let politicians get
away with this ALL THE TIME?  Every time that politicians are fighting
against budget cuts or for a tax increase, they always threaten that
the most critical possible services will be cut.  Its always emergency
workers that are going to be cut or the Washington Monument that is
going to be closed.  Its never the egg license program that has to be cut.

Update: Here is the form letter the governor's office sent out in response to my letter:

A weakened national economy and auto-pilot state spending has created a projected budget shortfall of $14.5 billion for fiscal year 2008-09. Although state government revenues this coming year are actually forecast to hold steady, the problem is that every year automatic spending formulas increase expenditures.  Left unchecked, next year's budget would need to grow by 7.3-percent, which is $7.6 billion; even booming economies can't meet that kind of increase.  To immediately combat this crisis, the Governor has proposed a 10-percent reduction in nearly every General Fund program from their projected 2008-09 funding levels.  While these reductions are unquestionably painful and challenging, this across-the-board approach is designed to protect essential services by spreading reductions as evenly as possible.

To achieve this difficult reduction, State Parks will be reducing both its permanent and seasonal workforce.  As a result, 48 park units will be closed or partially closed to the public and placed in caretaker status.  By closing parks and eliminating positions, remaining resources can be consolidated and shifted to other parks to provide for services necessary to keep those parks open and operating.  While 48 parks are affected by closures, 230 parks-or 83% of the system-will remain open.

We must reform our state budget process.  Government cannot continue to put people through the binge and purge of our budget process that has now led to park closures.  That's why the Governor has proposed a Budget Stabilization Act.  Under the Governor's plan, when revenues grow, Sacramento would not be able to spend all the money.  Instead, we would set a portion aside in a Revenue Stabilization Fund to stabilize the budget in down years.  If a deficit develops during the year, instead of waiting to accumulate billions of dollars of debt, the Governor's plan would automatically trigger lower funding levels already agreed upon by the Legislature.  Had this system been in place the past decade, we would not be facing a $14.5 billion deficit. 

As Governor Schwarzenegger works with his partners in the Legislature, he will keep your concerns in mind.  With your help, we will turn today's temporary problem into a permanent victory for the people of California.

The Arizona Republic this morning had some goofy headline in their print edition that said something like "How should you spend your $800 tax rebate?"  Far be it for me to presume to tell people how to spend their own money (what do I look like, a Congressman?) but here is a bit of advice:  Save it.  Because this is not a grant, it is a loan.

All of these rebates will be paid for with additional deficit spending.  This means that everyone will eventually pay for their rebate in the form of a) higher future taxes; b) higher future prices due to inflation; or c) increased job insecurity and/or lower future earnings due to reduced output in the economy; or d) all of the above.

It HAS to be this way.  Unlike private wealth creation, the government can't get wealth from nowhere.

The WSJ ($) has an article on California showing the growth of expenditures and the budget deficit.  I took the expenditures numbers and converted them to 2007 dollars and put them on a dollar per state resident basis, to correct both for growing population and inflation.  Here are California government general fund expenditures on a 2007 dollar per person basis:

1990-1991: $2,755
1995-1996: $2,470
2000-2001: $3,558
2005-2006: $3,416
2007-2008: $3,767

From these figures, we can learn a couple of things.  First and foremost, the state of California demonstrates itself to be just as financially incompetent as any condo-flipping doctor who now finds himself stuck with a bunch of mortgages he can't pay.  Lured by the false prosperity of the Internet bubble, California increased real government spending per resident by nearly 50% in the latter half of the nineties, and has done nothing to reign this spending in (thus the deficits).  The only place where the analogy with the person caught short by the housing bust falls apart is that the person with expensive mortgages is probably not out buying a new Mercedes and big screen TV, whereas that is exactly what California is doing, passing a $14 billion a year health care plan that will whose price tag can only rise.

The Anti-Planner has a series of posts of late on light rail that in total point to a perverse moral hazard in public transportation funding that helps to explain why states and cities are building so many rail projects, when the numbers almost never make any sense (as I blogged for LA, Phoenix, and Albuquerque).  Though the Anti-Planner does not state these rules, from his recent posts I have inferred three rules:

• A city can get capital construction dollars from the feds, but you can almost never get maintenance or operations money (similar story in recreation)
• The feds will fund big, expensive, sexy rail projects.  They will not fund purchases of buses and are unlikely to fund something so prosaic as a bus stop or terminal  (general rule of thumb:  federally funded projects must be large enough to justify being named at some future point after the local Congressman or Senator who earmarked the project.)
• It is very easy to de-fund bus systems -- you just don't replace aging buses and cut routes over time.  It is hard to de-fund, or, god forbid, abandon a rail line, since the thing sits out there so visibly.  Sunk costs can also be a political issue if rail lines were to be closed.

For most public transportation goals, particularly in spread out western and southern cities, buses are a cheaper and higher service solution than rail.  They can carry the same passenger traffic for far less total dollars (capital plus operating costs) and they can cover far more routes.  In fact, one can argue that rail lines are inherently regressive, as they tend to serve commuting corridors of the middle and upper classes rather than the typical routes of the poor, for whom the systems are nominally built.

So what can one expect by the application of these three rules?  Well, we would expect local authorities to favor large, expensive capital rail projects rather than refurbishment or expansion of bus systems.  As operating costs rise for the trains, we would expect bus service to be cut back to pay for the rail operating deficit.

Which is exactly what happens.  In fact, rail tends not to increase total ridership at all, at best shifting ridership from inexpensive buses to expensive trains, and at worst decreasing total ridership as rail lines with just  a few stations and routes replace more extensive webs of bus transport.  And, in twenty years, when these rails systems need extensive capital overhauls, we find cities with huge albatrosses on their hands that they are unable to maintain or update.

Via the Washington Post:

It has become a Capitol Hill ritual: A few senators, always including the New York Democrat Charles E. Schumer, introduce a bill to punish China
if its leaders do not raise the value of the nation's currency. Photos
are taken, news releases are issued, but nothing really happens.

This
year, the atmosphere on the Hill is markedly different. Powerful
senators from both sides of the aisle, Schumer among them, are pushing
two bills that threaten retaliatory action if China does not budge. For
the first time, the idea is gaining broad support. The bills are moving
swiftly through the Senate, and many analysts expect one will pass.

If the bill's authors are successful, the effect at a minimum will be to raise consumer prices in the United States and lower them for Chinese citizens.  So we are going to "punish" China by making our own citizens pay higher prices.  How does this make any sense?  Also, in the process, let's make sure we reduce the capacity of China to buy US government debt, which to this point has been reducing the cost of the Federal budget deficit.

Tyler Cowen argues this is the best we can expect -- the worst is a substantial debalization in the Chinese economy... and ours.  I wrote much more on continuing to allow the Chinese government to subsidize American consumers here.

From today's WSJ ($) online:

Turning aside growing congressional anger over low everyday prices, President George W. Bush's
administration today will reject demands that it formally accuse
Beijing of subsidizing lower prices for U.S. consumers.

With U.S. lawmakers gearing up to punish China for using Chinese funds to subsidize low U.S. consumer prices, Treasury
Secretary Henry Paulson is expected to use a semiannual currency
report, to be released today, to reinforce his calls for Beijing to
allow prices in the U.S. to rise faster....

OK, I confess I fibbed a bit.  The actual article reads:

Turning aside growing congressional anger over the
U.S. trade deficit with China, President George W. Bush's
administration today will reject demands that it formally accuse
Beijing of "manipulating" its currency to give Chinese companies an
edge over American businesses.

With U.S. lawmakers gearing up to punish China for
keeping the yuan artificially weak against the dollar, Treasury
Secretary Henry Paulson is expected to use a semiannual currency
report, to be released today, to reinforce his calls for Beijing to
allow the yuan to rise faster. But Mr. Paulson won't brand China a
currency manipulator despite congressional demands that he do so.

But it means the same thing as my version.  Thanks to Congress for looking after us consumers.  Our Chinese sister publication Panda Blog addressed these issues from the Chinese perspective a while back.  In short, the Chinese are wondering what we are complaining about:

Our Chinese government continues to pursue a policy
of export promotion, patting itself on the back for its trade surplus
in manufactured goods with the United States.  The Chinese government
does so through a number of avenues, including:

• Limiting yuan convertibility, and keeping the yuan's value artificially low
• Imposing strict capital controls that limit dollar reinvestment to low-yield securities like US government T-bills
• Selling exports below cost and well below domestic prices (what
  the Americans call "dumping") and subsidizing products for export

It is important to note that each and every one of these
government interventions subsidizes US citizens and consumers at the
expense of Chinese citizens and consumers.  A low yuan makes Chinese
products cheap for Americans but makes imports relatively dear for
Chinese.  So-called "dumping" represents an even clearer direct subsidy
of American consumers over their Chinese counterparts.  And limiting
foreign exchange re-investments to low-yield government bonds has acted
as a direct subsidy of American taxpayers and the American government,
saddling China with extraordinarily low yields on our nearly $1
trillion in foreign exchange.   Every single step China takes to
promote exports is in effect a subsidy of American consumers by Chinese
citizens.

This policy of raping the domestic market in pursuit of exports
and trade surpluses was one that Japan followed in the seventies and
eighties.  It sacrificed its own consumers, protecting local producers
in the domestic market while subsidizing exports.  Japanese consumers
had to live with some of the highest prices in the world, so that
Americans could get some of the lowest prices on those same goods.
Japanese customers endured limited product choices and a horrendously
outdated retail sector that were all protected by government
regulation, all in the name of creating trade surpluses.  And surpluses
they did create.  Japan achieved massive trade surpluses with the US,
and built the largest accumulation of foreign exchange (mostly dollars)
in the world.  And what did this get them?  Fifteen years of recession,
from which the country is only now emerging, while the US economy
happily continued to grow and create wealth in astonishing proportions,
seemingly unaware that is was supposed to have been "defeated" by Japan.

We at Panda Blog believe it is insane for our Chinese government
to continue to chase the chimera of ever-growing foreign exchange and
trade surpluses.  These achieved nothing lasting for Japan and they
will achieve nothing for China.  In fact, the only thing that amazes us
more than China's subsidize-Americans strategy is that the Americans
seem to complain about it so much.  They complain about their trade
deficits, which are nothing more than a reflection of their incredible
wealth.  They complain about the yuan exchange rate, which is set today
to give discounts to Americans and price premiums to Chinese.  They
complain about China buying their government bonds, which does nothing
more than reduce the costs of their Congress's insane deficit
spending.  They even complain about dumping, which is nothing more than
a direct subsidy by China of lower prices for American consumers.

And, incredibly, the Americans complain that it is they that run
a security risk with their current trade deficit with China!  This
claim is so crazy, we at Panda Blog have come to the conclusion that it
must be the result of a misdirection campaign by CIA-controlled
American media.  After all, the fact that China exports more to the US
than the US does to China means that by definition, more of China's
economic production is dependent on the well-being of the American
economy than vice-versa.  And, with nearly a trillion dollars in
foreign exchange invested heavily in US government bonds, it is China
that has the most riding on the continued stability of the American
government, rather than the reverse.  American commentators invent
scenarios where the Chinese could hurt the American economy, which we
could, but only at the cost of hurting ourselves worse.  Mutual Assured
Destruction is alive and well, but today it is not just a feature of
nuclear strategy but a fact of the global economy.

Like many libertarians, I lose interest quickly in politics, watching partisans of the Coke party argue why they are so much different than the Pepsi party.  You don't have to watch the whole farce for very long as a neutral observer before you see the same people taking the opposite tack on an issue than they did a few years earlier, only because their guy is in office, so now its more OK than when the other party's guy was doing it.

But I do read a few political blogs from both sides, just to keep abreast of what is going on.  This weekend, both sides managed to irritate me over the same issue.  First, Kevin Drum, from the left, railed on what he called "the GOP economy," complaining that the economy has grown without increasing median wages (note he carefully avoids "total compensation," which has gone up.)  Then Captains Quarters wrote from the right that "The economy continues its growth under the stewardship of the Bush administration."

George Bush does not run the economy.  George Bush does not even make day-to-day decisions that affect the economy.  He has made a few major moves that have economic consequences, with the positive effects of tax cuts probably mostly offset by unrestrained deficit spending, random protectionist acts and new bloated government services.  Bill Clinton, while we have to credit him for NAFTA (see below), was not responsible for the incredible economic expansion of the 90's.  In fact, neither Bill Clinton nor his wife have ever held a job where they produced anything. 

All of which is fine - I am not accusing president's of somehow falling down on the job.  I am merely stating what I thought was obvious.  Wealth is created by the actions and the minds of hundreds of millions of people, to whom the occupant of the White House is largely irrelevant except insofar as the President  substantially increases or reduces the artificial burden of efficiency-sucking government mandates, reporting, and taxes.

I will go into more depth on this in my annual tax day post, but I am increasingly confident of my theory of wealth creation.  Wealth is increased as two things happen:

• More individuals are more free to (and more likely to) question established beliefs, either scientific (e.g. the earth-centric universe), social (e.g. racial prejudice) or business (e.g. primacy of mainframe computing).
• More Individuals are more free to act in their own self-interest to pursue the results of their insights and to keep for themselves the proceeds of their efforts.

Since the 1970's, we have seen an explosion in the global economy, which has greatly increased the number of people working on any given economic problem.  For example, instead of just people in Detroit and Germany thinking about how to design and produce cars, we have folks in Japan and South Korea and even China and Brazil questioning the established wisdom from Detroit.  This has resulted not just in better, more affordable cars, but in production and supply chain management techniques that have made nearly every industry you can name more productive. 

Whenever such a change occurs, there are conservative (lower-c) forces that try to halt them.  The Church used its power for a time to resist the heliocentric view of the solar system.  Southern states used Jim Crow laws to resist post Civil War racial and social reforms.  And any number of groups wanted (and still want) to slam the door on the global economy.  Many countries in Europe went down this path.  What has saved the US from the same low-growth fate they have in Europe (and Japan) is that the government, and Bill Clinton in particular, at a critical time resisted the technocratic urge to have the government "do something" about the economic changes flowing from globalization.  Some wanted protectionism, while some wanted a more active hand by the government in "choosing winners" in the economy, like it was perceived that Japan had.  Bill Clinton resisted resisted these voices, most of whom were powerful in his own party, and in fact doubled down on globalization by pushing NAFTA.  For this act of vision, Clinton should be credited, but I still wouldn't call it "his" economy. 

Seldom do I plagiarize editorial titles - I usually try to make up my own post title, even if mine is not as good as the original.  But how can you not give kudos to an MSM editorial like this:

An iPod for every kid? Are they !#$!ing idiots?

The Detroit News

We have come to the conclusion that the
crisis Michigan faces is not a shortage of revenue, but an excess of
idiocy. Facing a budget deficit that has passed the $1 billion mark,
House Democrats Thursday offered a spending plan that would buy a MP3
player or iPod for every school child in Michigan.

No cost estimate was attached to their hare-brained idea to "invest" in education. Details, we are promised, will follow.

It is good to see a MSM outlet treating this type of stupid populist government proposal with all the seriousness it deserves.  I wish they would cry foul more often.  Via Hall of Record.

This observation is apropos of nothing, but I have noticed something odd about the sales efforts of companies.  They seem to be either too aggressive or downright dormant.

I answer my own phone at work, so every day I hear the parade of people calling me asking for the "person who purchases your printer supplies."  Certain industries, including toner, office supplies, telecom, etc. seem to have irritatingly aggressive sales forces.

And then we have companies like Wham-O.  Yes, the toy guys.  We opened a new snow play area and are selling hundreds of plastic sleds a week.  Unfortunately, we can't find any manufacturer to talk to us about a distribution deal.  So one of my managers spends a part of each week combing every Sams Club and Wal-Mart in Northern Arizona to buy plastic sleds for resale.  I have called Wham-O, a large maker of these sleds, about twenty times.  I have talked to many different people.  I have been referred to several different reps and even the head of the sales department.  And no one will return my call, despite a plea that I want to buy hundreds of sleds a week. 

It is possible that in this Wal-Mart world, volume of this size from one retail outlet is not worth pursuing, but this casualness about making a sale really amazes me.  I would chalk it up to some unique circumstance at Wham-O, but I have had this experience with a number of other companies.  I can't tell you how many times I have left plaintive messages to firms saying "I want to buy a bunch of your product, can someone please call me back to tell me how."

Weird.  Fortunately, we finally had a Canadian company today actually returned our calls and was more than happy to sell us large lots of their product.  Oops, there goes the trade deficit.

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?

Sorry posting has been light this week.  A reader was nice enough to point to the latest rant by Lou Dobbs here.  Apparently, he has decided to take the position that free traders are now elitists, while folks like him who want the government to pick and choose winners among American businesses and industries as "populist."  The obvious response of course is that beneficiaries of American protectionist legislation tend to read as the who's who of politically connected elitists.  It is also hilarious to equate free trade, whose benefits are backed by 100 out of 100 economists, with some irrational faith-based belief system.  But I will leave that aside to point to this line:

He and others completely disregard the $5 trillion in trade debt that
the United States has built up through 30 consecutive years of trade
deficits. That trade debt is rising faster than our national debt and
is simply economically unsustainable, no matter what any faith-based
economist would argue. Our political, business and media elites
continue to disregard reality.

Here is my very, very simple challenge for Lou Dobbs to help those of us who obviously don't get it:  Point to where this $5 Trillion of Debt is.   What private individuals or corporations owe it to whom?  That should be simple.  With the national debt, we can just go out and count all those government bonds.  But where is this trade "debt"?

Answer:  IT DOESN'T EXIST.  What he means is that over some time span of several decades, American has a cumulative trade deficit of $5 trillion.  But trade deficit does not mean debt.  I showed this in great detail here.  Calling it a "trade debt" is not a sloppy mistake on Dobbs part but an outright lie, meant to make the point that running deficits every year is unsustainable.  But America has become the wealthiest country in the world running trade deficits for the majority of the last 100 years.   In fact, one can argue that the trade deficit itself only exists as a phantom of the awkward and limited way in which we measure trade. 

Postscript: I constantly get people who write me that the fact the Chinese are buying up a lot of US government bonds or corporate bonds with their trade profits is proof of a "trade debt."  No such thing.  The US Government bonds are evidence of a fiscal deficit of the federal government, also called the national debt, and exists not because of trade but because Congress has no fiscal discipline.  Corporate debt is growing to buy back stock, make corporate acquisitions, and to buy new plants and facilities.  The fact the Chinese help to fund these debts does not mean that trade caused this debt.  In fact, foreigners buying US debt securities depresses interest rates and actually keeps the national debt lower.

Here is a thought experiment:  Wal-Mart runs a multi-billion dollar trade deficit every year with China.  Why isn't it building up lot's of debt to the Chinese?

I have been thinking about this previous post on trade and wanted to improve my answer to Jon Talton, our free-markets-hating business columnist in the Arizona Republic.  In his recent column advocating that we finally give up on all this free trade stuff, he said:

Americans were assured that new trade accords and China's membership in
the World Trade Organization would mean better living standards for
American workers. That's because China and other countries supposedly
would buy American exports.

I thought my answer was OK, but I want to take another shot at it, because I hear the argument all the time that "trade only benefits the US if other countries buy our exports."  This is wrong, but this misconception drives many people's thinking on trade.

If we are importing more from other countries but they are not "buying more of our exports," such that we have a large trade deficit, there are two possibilities to explain this:

• The definition of exports is too narrow
• Someone is throwing away value by building up a big pile of US dollars

The first is the most likely explanation.  A dollar is valueless in China, and the UK, and France except to the extent someone thinks they can eventually use it to buy something in the US.  Dollars that aren't or can't be used to buy dollar-denominated assets of some sort have no value.  The money a Chinese exporter accepts from Wal-mart is only valuable if they can recycle it and buy something in the US with it (or trade the dollars to someone else in China who wants to buy something in the US). 

So the dollars we send overseas for imports are going to come back.  But the  reason our trade accounts are out of balance is that the trade deficit numbers they quote on TV define our exports narrowly.  In short, "exports" as commonly measured don't include all the things we sell to foreigners for dollars.

One example of this is if a Chinese company takes the $10 million dollars it earns from exporting to the US and then invests $10 million in US materials to build a factory in the US.  That sounds OK, right?  That seems to be in balance.  But in the way we calculate the trade deficit, that would show as a $10 million trade deficit, because goods (and services) that foreigners buy in the US and consume in the US (rather than back in their home countries) are not considered an "export."  In fact, I would consider this "better" than an export, since both the dollars and the goods stay in the US.  But to trade deficit hawks, this is worse, mainly because their measurement is flawed.

A second example is if a Chinese company take the $10 million dollars it earns from exporting to the US and invests the money in US mortgage bonds.  Again, this would show as a trade deficit, but the US economy benefits from lower interest rates.  In this case, we are again selling foreigners a product, in this case wealth protection, which the US is very good at since we have a more stable economy and stronger rule of law than any other country in the world.  And again, the way we measure "export" does not encompass this product, since our trade measurement has a strong manufacturing bias that does not match the more diverse nature of our economy today.  (For those that lament forefingers helping to fund the enormous government debt, I share your pain, but that is a government spending problem and not a trade problem).

But what if the foreigners are totally perverse.  What if they ignore their own best interests and refuse to buy our exports and just sit on the dollars they get from trade without recycling them in any way to the US?  What if they do this even if by doing so, they would be throwing away billions, even trillions of dollars in value?  As absurd as this sounds, this is exactly the concern Talton and other trade-skeptics raise.

Well, the US in this case would STILL be better off.  First, the US would be getting whatever goods we are buying overseas cheaper or better (or else people would not be buying them).  This would reduce the costs of inputs to other products, and increase money consumers have to spend on other things.  The labor that would have gone into making these products domestically would be redeployed to making other things, increasing our net wealth. 

By the way, it is this last sentence I think Talton and his peers would not accept.  They tend to view employment as zero-sum, ie there are a fixed number of jobs in the world, and if we import, that creates jobs overseas which must reduce jobs in the US.  But labor markets have never worked that way.  As I wrote before:

I have taken on this zero-sum mentality before,
but it is particularly wrong-headed in this case.  Historically, the
argument makes no sense.  For example, the automation of the farm
sector wiped out 80 or 90% of the farm jobs in the US over the last
century.  By the zero-summers logic, we should be impoverished.
Instead, these people were redeployed to manufacturing and service jobs
that create far more wealth than the old 19th century farm employment.
But while people can sort of accept this historically, they can never
accept this in real-time.  But the fact is that when we lose, say, a
textile job to foreign competition, we not only gain because everyone
pays less for textiles and thus has more money to spend on other
things, but that worker gets redeployed over time to higher-value
functions.  Look at the old textile belt in North Carolina - what's
there now?  Electronics and Bio-tech.

By the way, the other thing that would occur if foreigners just buried dollars in the sand without recycling them is that the value of the dollar would rise to levels higher than it would be at if these countries recycled their dollars, thus further lowering the price of inputs for the US.  Talton laments this very effect:

Now, the populists will get a chance to make their arguments,
especially over what the American response should be to Chinese
currency manipulation, tariffs and subsidized exports.

The currency manipulation and subsidized exports have one thing in common:  They are both ways that the Chinese destroy value for their own citizens in order to lower prices for American consumers.  And Talton claims that the populist argument should be to end these practices?  Why?  I think its great that the Chinese want to hold billions in dollars just to keep the dollar high and prices low in the US.  I think its great that their taxpayers want to subsidize lower prices in the US.   I can understand why a Chinese citizen might want this to stop, but why should we, who are the beneficiaries?

Update: By the way, another common misconception is that a trade deficit implies someone is building up a debt.  This is not (not not not) at all true.  We can run a trade deficit indefinitely without building up a debt.  Yes, foreigners are currently investing some of their trade profits in US government bonds necessitated by the federal government's deficit spending, but the two are only weakly related - a trade deficit does not cause government debt.  A great way to see if a columnist has any idea what they are talking about is to see if they confuse the federal budget deficit with the trade deficit.  It is almost funny how often I see this confusion appears in print.  Anyway, this confusion is why people like Talton call the trade deficit "unsustainable".  See my posts on why the trade deficit is not a debt (and here).

From Marginal Revolution:

The FASAB has asked
that the United States government start including future Medicare and
Social Security liabilities in current budget deficit figures:

Monday,
the Federal Accounting Standards Advisory Board released a proposal in
which the government would have to account for the cost of future
Social Security payments year by year as people build up entitlements.

Seen in advance of its release by the Financial Times, the switch in
accounting practices would be an international accounting anomaly, as
most other governments treat social insurance as a political commitment
to pay future benefits rather than a financial liability, the newspaper
said.

The FASAB is made up of six independent members who support the
proposal and three opposing members from the U.S. Treasury, the White
House Office of Management and Budget and the Government Accountability
Office.

I support this change despite the fact it may result in what I consider bad outcomes (e.g. big tax increases) as the magnitude of future liabilities become clear.  Tyler Cowen also argues it may make these programs harder to scale back, since it shifts the future payments from a political promise to a financial commitment.  But just like free speech, one has to be consistent in one's support for transparency.

If this all seems arcane to you, let me give you some perspective.  Today, Jeff Skilling was given over 30 years in jail for various accounting-related frauds, supposedly hiding losses and liabilities from shareholders's view.  But what Skilling was convicted of doing were minor, subtle accounting tricks involving penny-ante sums of money compared to the egregious games Congress plays with accounting for the federal government's future liabilities.  Skilling was accused, for example, of booking future liabilities in certain joint ventures where they were hard to find; the feds, in contrast, do not book future liabilities at all.

A reader emailed me this article about the Endangered Species Act at work:

The sharp chirps of the endangered red-cockaded woodpeckers and the
whine of chain saws sound discordantly in this coastal community of old
pine forests....

The woodpecker's status as an endangered species requires special
measures to try to prevent its extinction and restore its population,
wildlife officials say. That's the law. Wildlife officials gave the
town maps pinpointing woodpecker nests. No building or tree cutting is
allowed within 200 feet of a nest tree without a federal permit. Some
restrictions on development also apply to 75-acre circles around each
nest site to provide foraging area for the birds....

Since word got around this spring that owners could
face problems selling land or building houses where the birds lived,
people have been rushing to clear undeveloped lots of pine trees and
yanking the woodpecker welcome mat.

More than anywhere else in
North Carolina, Boiling Spring Lakes is a place where the coastal
development boom and the federal Endangered Species Act have collided.

"People
are just afraid a bird might fly in and make a nest and their property
is worth nothing," said Joan Kinney, mayor of Boiling Spring Lakes in
Brunswick County. "It is causing a tremendous amount of clear-cutting."...

Bonner Stiller, a state lawmaker from Brunswick County, has owned a
pair of lots as an investment here for more than 20 years. He cleared
them recently. Stiller said he was sorry to lose the trees but wanted
to protect his investment.

"You had to get in line to get
somebody with a chain saw," Stiller said. "I have not a single pine
tree left. Folks around here are terrified of the prospect of losing
their property. That causes people to get out there and find out what
they can do to protect themselves."

In the past, I have divided environmental law into two categories:  emissions law, which is not only consistent with but a must for the maintenance of a strong property rights regime; and land use law, which tends to be an affront to property rights.  You can read more on this distinction here.  This situation is a great example of why land use environmental law is such a problem.

Take a step back.  Consider that some (but by no means all) people in this country value the continued existence of the red-cockaded woodpecker.  There are several ways they might pursue this goal, which I will put in order of decreasing attractiveness:

• They can get together, voluntarily pool their money, and seek to purchase land that might be habitat for the woodpecker and voluntarily set aside what is now their land from development.  This is the best solution, and the only one that operates without resorting to the use of force against individuals.  Oranizations like the Nature Conservancy and other land trusts work this way.
• They can get the government to tax everybody in the country a few extra cents, flow these cents together into big dollars, and have the government buy the land (or seize it via eminent domain) and set it aside as open space or parkland.  This takes money by government force from people who don't value the woodpecker's survival, but at least it spreads the cost wide and thin.
• They can get the government to declare that the twenty-five or thirty people who have these birds on their land can no longer do anything, from development to tree-cutting, on their land.  This option is the worst, because it lands the entire cost of the woodpecker's survival on just a few individuals, and it costs these individuals inordinately high amounts of money in the form of reduced property values  (if you can't do anything to a piece of raw land, the resale value effectively drops to zero).  I personally hold a piece of raw land for future development of a vacation or retirement home.  A substantial portion of my net worth is in this land.  If it were to be suddenly made worthless, much of my life's savings would be gone.

As an interesting note, I have ranked these options in descending order with an eye to fairness and individual rights.  However, if we instead rank these options from the perspective of the average Congressman and his/her political calculations, we actually get the reverse order!  The first option of private action is the worst from your average Congressman's point of view, because then there is nothing they can take credit for in their next election campaign.  The second option is better, but would involve a tax or deficit increase he might conceivably be dinged for.  The third is the best for our average politically-calculating Congress critter, since it results in an outcome he can take credit for with important interest groups, and the costs are almost totally hidden, and born by just a few people who don't have many votes and may not even be in his district.  Not surprisingly, this is the approach Congress has taken, via the Endangered Species Act.

There is some hope that this problem may eventually get worked out the right way, at least in Boiling Springs Lake:

The Nature Conservancy hopes to help. Since 1999, it has acquired about
6,500 acres that form a horseshoe around the center of town. The land,
much of which is wetlands, has two groups of woodpeckers. Woodpeckers
typically nest in clusters of 3 or more birds with one breeding pair
and helpers. In time, the land could support six or eight clusters as
the conservancy adds more land for a nature preserve.

Expect the next Democratic presidential nominee to run strongly on single-payer (ie socialized) medicine.  Vodkapundit reminds us what this is like, with the latest from England:

Hospitals across the country are imposing minimum waiting times -
delaying the treatment of thousands of patients.

After years of Government targets pushing them to cut waiting lists, staff
are now being warned against "over-performing" by treating patients too quickly.
The Sunday Telegraph has learned that at least six trusts have imposed the
minimum times.

In March, Patricia Hewitt, the Secretary of State for Health, offered her
apparent blessing for the minimum waiting times by announcing they would be
"appropriate" in some cases. Amid fears about £1.27 billion of NHS debts, she
expressed concern that some hospitals were so productive "they actually got
ahead of what the NHS could afford".
...

The Sunday Telegraph has learned of five further minimum-waiting-time
directives. In May, Staffordshire Moorlands PCT, which funds services at two
hospitals and is more than £5 million in the red, introduced a 19-week minimum
wait for in-patients and 10 weeks for out-patients. A spokesman said: "These
were the least worst cuts we could make." In March, Eastbourne Downs PCT,
expected to overspend by £7 million this year, ordered a six-month minimum wait
for non-urgent operations. Also in March, it was revealed that Medway PCT, with
a deficit of £12.4 million, brought in a nine-week wait for out-patient
appointments and 20 weeks for non-urgent operations.

Doctors are also resigning. One gynæcologist said that he spent more time
doing sudoku puzzles than treating patients because of the measures. Since
January, West Hertfordshire NHS Trust, with a deficit of £41 million, has used a
10-week minimum wait for routine GP referrals to hospital. Watford and Three
Rivers PCT, £13.2 million in the red, has introduced "demand management": no
in-patient or day case is admitted before five months.

Note that this is not a bug with single-payer systems, it is a feature.  Any 3rd party payer system has to impose some sort of artificial rationing or bankruptcy will ensue.  Would you drive more if your gasoline costs were all covered by a single-payer system, such that you did not pay directly for gas.  Would your choice of cars be affected?

Along the same lines, from Marginal Revolution comes this story of new scholarship showing the enormous spike that occurs in health care demand under third party payer (e.g. insurance) systems.

From Don Boudreaux at Cafe Hayek:

In yesterday's Wall Street Journal, Lawrence Lindsey wrote
about the Chinese government's policy of not allowing the value of the
yuan to rise against that of the dollar:

America, however, benefits from this arrangement. The Chinese clearly
undervalue their exchange rate. This means American consumers are able
to buy goods at an artificially low price, making them winners. In
order to maintain this arrangement, the People's Bank of China must buy
excess dollars, and has accumulated nearly $1 trillion of reserves.
Since it has no domestic use for them, it turns around and lends them
back to America in our Treasury, corporate and housing loan markets.
This means that both Treasury borrowing costs and mortgage interest
rates are lower than they otherwise would be. American homeowners and
taxpayers are winners as a result.

The Chinese are holding on to a Trillion dollars in US currency, with the main effect of subsidizing lower prices and interest rates for US consumers.  What a deal!  (I took a more tongue-in-cheek approach to the same issue here)  I know most commentators instead want to focus on the threat of China suddenly dumping those dollars, disrupting US markets.  People need to understand that the cost of doing the latter is enormous for China, not only in lost value of their dollar-denominated assets but in lost exports as the value of the Yuan would spike.  To test the hypothesis of holding dollars as a strategic weapon, would you feel more secure in the US if the government held a trillion dollars of yuan?  Why?  I would in fact feel more vulnerable to China, dependent on the health of their economy.  I personally am a big believer that Chinese investments in the US are great, and will act as a stabilizing influence in the future. 

By the way, while the above refers the Chinese government holdings of US financial assets, Cafe Hayek also points to an article by John Makin of the AEI who observes that the trade deficit is a misnomer, as the US is providing services that are not counted, specifically wealth-protection services:

In summary, Makin argues that one of the reasons foreigners sell so
many goods and services to Americans and then consistently refrain from
buying an equivalent amount (in value terms) of goods and services from
Americans is that foreigners have a high demand for "wealth-storage"
services supplied by dollar-denominated assets.

The fact that global savers accommodate U.S.
consumers by keeping U.S. interest rates lower than they otherwise
would be and the dollar stronger than it otherwise would be is simply a
manifestation of America's comparative advantage at supplying wealth
storage facilities.

In
other words, there's no real imbalance.  If the services supplied by
"wealth-storage facilities" were counted in international commercial
accounts as "services," then the U.S. current-account would not be in
deficit.

I have written before about why we should not fear the trade deficit with China, and why the word "deficit" is itself a misnomer, here and here.

The following is from our Chinese sister publication called Panda Blog:

Our Chinese government continues to pursue a policy of export promotion, patting itself on the back for its trade surplus in manufactured goods with the United States.  The Chinese government does so through a number of avenues, including:

• Limiting yuan convertibility, and keeping the yuan's value artificially low
• Imposing strict capital controls that limit dollar reinvestment to low-yield securities like US government T-bills
• Selling exports below cost and well below domestic prices (what the Americans call "dumping") and subsidizing products for export

It is important to note that each and every one of these government interventions subsidizes US citizens and consumers at the expense of Chinese citizens and consumers.  A low yuan makes Chinese products cheap for Americans but makes imports relatively dear for Chinese.  So-called "dumping" represents an even clearer direct subsidy of American consumers over their Chinese counterparts.  And limiting foreign exchange re-investments to low-yield government bonds has acted as a direct subsidy of American taxpayers and the American government, saddling China with extraordinarily low yields on our nearly $1 trillion in foreign exchange.   Every single step China takes to promote exports is in effect a subsidy of American consumers by Chinese citizens.

This policy of raping the domestic market in pursuit of exports and trade surpluses was one that Japan followed in the seventies and eighties.  It sacrificed its own consumers, protecting local producers in the domestic market while subsidizing exports.  Japanese consumers had to live with some of the highest prices in the world, so that Americans could get some of the lowest prices on those same goods.  Japanese customers endured limited product choices and a horrendously outdated retail sector that were all protected by government regulation, all in the name of creating trade surpluses.  And surpluses they did create.  Japan achieved massive trade surpluses with the US, and built the largest accumulation of foreign exchange (mostly dollars) in the world.  And what did this get them?  Fifteen years of recession, from which the country is only now emerging, while the US economy happily continued to grow and create wealth in astonishing proportions, seemingly unaware that is was supposed to have been "defeated" by Japan.

We at Panda Blog believe it is insane for our Chinese government to continue to chase the chimera of ever-growing foreign exchange and trade surpluses.  These achieved nothing lasting for Japan and they will achieve nothing for China.  In fact, the only thing that amazes us more than China's subsidize-Americans strategy is that the Americans seem to complain about it so much.  They complain about their trade deficits, which are nothing more than a reflection of their incredible wealth.  They complain about the yuan exchange rate, which is set today to give discounts to Americans and price premiums to Chinese.  They complain about China buying their government bonds, which does nothing more than reduce the costs of their Congress's insane deficit spending.  They even complain about dumping, which is nothing more than a direct subsidy by China of lower prices for American consumers.

And, incredibly, the Americans complain that it is they that run a security risk with their current trade deficit with China!  This claim is so crazy, we at Panda Blog have come to the conclusion that it must be the result of a misdirection campaign by CIA-controlled American media.  After all, the fact that China exports more to the US than the US does to China means that by definition, more of China's economic production is dependent on the well-being of the American economy than vice-versa.  And, with nearly a trillion dollars in foreign exchange invested heavily in US government bonds, it is China that has the most riding on the continued stability of the American government, rather than the reverse.  American commentators invent scenarios where the Chinese could hurt the American economy, which we could, but only at the cost of hurting ourselves worse.  Mutual Assured Destruction is alive and well, but today it is not just a feature of nuclear strategy but a fact of the global economy.

Panda Blog goes on to ask that their government end these distorting policies, for the sake of China's future.  I for one kindof hope that they keep subsidizing the stuff I buy over at Wal-mart...

I have been stuck in rural Colorado a few days, my stay extended by a pretty good spring snowstorm up in the high country.  I was visiting our new Colorado marina.  Finally getting to the airport, I found a backlog of unapproved comments, which I have passed through in mass.  Sorry for the delay, but blame spam-bots.  I hate having to approve comments to filter spam as much as you must hate the delay in seing your comments appear.

The other day in this post I, for the first and last time, wrote that my commenters needed to educate themselves.  I knew this was a stupid thing to write, leading with my chin, as it were.  I have posted all kinds of dumb stuff, and a number of things that I have been informed were outright errors (see the update to that same post, for example).  My commenters are great and often more knowlegeable than I am, so it was a dumb tone to adopt.  My only excuse is that I had about 5 emails in a row that confused the trade deficit with the federal budget deficit and the national debt, and I was ready to scream. 

I'm sorry.

After spending gobs of electrons on this post about the US trade deficit explaining why it is not a debt, and is not even necessarily bad, I got a depressing number of comments and emails like this one:

The trade deficit is a debt. We cannot get the dollars back we have
spendt unless we export to get them back. It is called an external debt
for a reason. It is called a current account debto for a reason.

Aaaaargh.  It is depressing that we can get such economic ignorance, particularly in a self-righteous way.  The crappy media coverage of these issues has people convinced that it just has to be this big old debt out there someone is going to have to repay someday. 

OK, I will try again.  But in response to this specific post, it is only called "external debt" or "current account debt" rather than "deficit" by really, really sloppy media people who have no idea what they are talking about (unfortunately, there are a lot of these).  And a deficit is not a debt, though it can sometimes create a debt.

I try to be very respectful of my readers.  I never delete a comment, unless it is spam/bot stuff or in a few cases where commenters have asked me to.  So it is only with the deepest respect that I say the following:  Please do not bother to comment on this post if a) you do not understand the difference between the federal government deficit and the trade deficit and/or b) you do not understand the difference between an account deficit and a debt.  Seriously.  Just take my word for it that you need to educate yourself a bit first, and then feel free to leap into the debate.  (Update:  This was a poor tone to adopt, see here).

First, A Thought Experiment

This is not meant to constitute proof, but for those who are concerned that the trade deficit is potentially disastrous for our economy, I can only ask, When?  Because we have been running a substantial trade deficit as a nation for over a quarter of a century, and by all accounts, over that same time period, we have had just about the strongest economy in the world.  In fact, I would propose that the causation is more likely just the reverse.  Because we have had a strong economy, with extraordinary wealth creation, we have taken some of that wealth and spent it on goods from other nations.  And because we have the safest nation in the world in which to invest, demand for our local investments tends to shift exchange rates in a way that increase the trade deficit.

In the late 80's and early 90's, everyone was in a panic about Japan.  We were running a massive trade imbalance with Japan.  They were going to buy all of our real estate.  Their government was tipping the scales in their own favor.  They were purposefully depressing the yen to encourage exports.  Blah, blah, etc, etc.  And you know what happened?  They subsequently went into a decade and a half long recession they are only just now climbing out of, and we had one of the strongest economies in history. 

How do the Dollars Get Back?

With a couple of exceptions that don't really change our conclusions, dollars do follow a closed loop.  In other words, if we send them to China or India, they generally eventually come back.   The question is how.  To understand this, it is first important to understand that the balance of trade deficit only measures some monetary flows.  In particular, it looks at the balance between manufactured goods traveling between two countries.  If the US has a $20 billion trade deficit with China, it means that they shipped $20 billion more of manufactured goods to us than we shipped back to them.  It includes some but not all services.  It does not include goods or securities or investments purchased by foreigners that remain on US soil.

To understand how the dollars come back from China in a closed loop is to, in a sense, ask the question of what monetary flows are not included in the trade deficit.  If we have a trade deficit with China, there are a number of things it can do with its extra dollars:

1. It can do nothing with them - just hold them in a big pile
2. It can lend the money to people buying their products
3. It can buy certain US services
4. It can buy US goods, but not take them out of the US
5. It can buy US public and private securities and real estate

Lets look at each in turn

1.  China can do nothing with them - just hold them in a big pile

Two words:  In-Sane.  By just holding them, they would effectively be sticking them in a mattress and foregoing any interest or investment income.  It's just not going to happen.  And don't say, well they could just put the dollars in a Chinese bank.  Fine, but the only way the Chinese bank is going to pay interest on dollars in the bank is if they turn around and invest the dollars in dollar-denominated investments.  One way or the other, the money, if it does not buy anything else, will get invested, which we will deal with in point 5.

I know there are paranoiacs that worry that the Chinese, despite the financial disincentives, will hold these dollars anyway in a big vault or something out of spite.  Gee, hurt me, hurt me.  Holding our dollars in a big mattress in Peking does nothing to hurt us.  And dumping them all on the market simultaneously may sound scary to conspiracy theorists, but in practice it would hurt them worse than it would hurt us, and the pain would be relatively short-lived  (just ask the Hunt brothers about this strategy).

2.  China can lend the money to people buying their products

I suppose that for those who don't get the federal deficit and the trade deficit mixed up, this is what they assume is happening, that Americans are borrowing from the Chinese to finance manufactured goods purchases.  The only problem is that it is not happening, at least to a greater extent than any normal purchase-financing arrangements.  Take corporations such as Wal-mart, a huge buyer of Chinese stuff.  Is Wal-Mart going into debt to buy Chinese stuff?  No, and certainly not to the Chinese. 

Well, are individual Americans going into debt to buy Chinese.  Maybe, but the key point is that they are not going into debt because what they are buying is Chinese.  They are going into debt because Americans, for whatever reason good or bad, are saving less and choosing to buy more on credit.  This would be happening if what they were buying was Chinese or American made.  In other words, American consumers may have debt, but that debt would exist even if we had no trade deficit with China.  It is a personal choice people are making that has no relation to the source of goods.

3.  China can buy certain US services

Note that many US services are not included in the trade deficit calculations.  If Chinese companies engage McKinsey & Co. consultants in the US to figure out how to sell more stuff to Wal-mart, those payments for services are probably bringing dollars back to the US from China, but aren't included in the trade calculations.  This really is just a subset of point four:

4.  China can buy US goods, but not take them out of the US

Many, many of the dollars the Chinese end up with come back to us in this way.  As did many of the dollars the Japanese had in the eighties.  If a Chinese company uses dollars not to buy US goods and take them back to China, but buy them and consume them in the US, then this does not show up in the trade numbers.  Chinese and Japanese companies bring their US dollars to the US to build factories and infrastructure.  This is sometimes why it is said that the trade deficit is not a measure of differences in cash flows, but of a difference in where goods are consumed. 

If you flip the equation around, the Chinese have a wicked balance of stuff deficit.  They are sending a lot more manufactured goods to the US than they get back.  I could argue that Chinese workers are getting hosed, since they only get to enjoy a fraction of the goods they produce for themselves, since a large portion of the product of their labor is sent overseas for others to enjoy.  Hmmm, doesn't sound so bad that way.

5.  China can buy US public and private securities and real estate

Of course, what happens with a lot of the US dollars the Chinese find themselves with is that these dollars get invested in US investment vehicles, from real estate to government bonds to private equities.  There are several points that need to be made here:

a.  Just Because Chinese invest in US Government Bonds does not make them or the balance of trade responsible for this debt

As I intimated above, a lot of people get the US federal budget deficit confused with the trade deficit.  Making this confusion worse, the Chinese use a lot of the dollars they earn in trade to buy US Government Bonds that help finance the federal budget deficit.  Now, by buying a lot of government bonds, one might argue that the Chinese lower interest rates and make government borrowing easier, thus making the federal budget deficit worse since there is a ready source of debt financing. 

While there may be a link here, it is tenuous at best.  If the government was a private company, then its borrowing level might rationally fluctuate up and down based on interest rates and capital availability.  But the US Government is not this rational.  It runs a budget deficit primarily because legislators and bureaucrats alike have the incentive to spend other people's money to protect their jobs and power base.  This happens equally at 3% interest rates and 9% interest rates.  It happens equally if guys from Peking or Omaha are buying government bonds.  In fact, one could argue that Chinese reinvestment of their trade dollars in US securities actually marginally reduces the government debt by reducing interest costs.

This same argument holds equally true for Chinese investments in private debt.  Chinese dollars may increase borrowing slightly, but only because the influx of their cash reduces borrowing costs.

b.  Chinese Ownership of US Assets is GOOD

In the Japanese scare of the 1980's, everyone was freaked out that the Japanese were buying up American assets and real estate.  During that time, while I almost never play the race card, it was almost impossible not to come to the conclusion that some racism had to be involved in this fear.  America had welcomed, in fact, had prospered, via foreign investment for years.  For a century, the US has been the safest place for foreigners to put their money,something we should be proud of  -- A sign of strength, not weakness.

But suddenly, everything was different because the new buyers were Japanese.  Note the following:

Despite the notoriety of
Japanese investors, the British have the largest U.S. direct investment
holding"”with the Dutch not far behind"”as has been the case since
colonial times. In 1990 the United Kingdom held about 27 percent of
foreign direct investment in the United States, significantly greater
than Japan's 21 percent. The European Economic Community (EC)
collectively holds about 57 percent. Moreover, according to research by
Eric Rosengren, between 1978 and 1987, Japanese investors acquired only
94 U.S. companies, putting them fifth behind the British (640),
Canadians (435), Germans (150), and French (113).

But no one was complaining about the British, Canadians, Germans, or French.  Only the Japanese.  I have to come to the conclusion that there was some racism involved, with the same primal fears at work that caused us to ship US citizens of Japanese decent off to concentration camps in WWII but we did not do the same of citizens of German or Italian decent.  And in this case, it could not have been security concerns.  Since 1945, Japan is one of the most pacifistic nations in the world- we probably face a bigger security threat from Belgium than we do from Japan.

I get the same feeling today with the China panic that I did twenty years ago with Japan.  Its a race and a culture we don't understand well, so we get xenophobic.  People lament that China is a real security threat, and that certainly is true to an extent.  But ask yourself this - Is China more or less of a threat to hurt us if their economy, their financial prosperity, and most of their assets are tied to the US?  Is China more or less stable now that their people are not starving and they are rapidly developing the largest middle class in the world?

Conclusion

If you are still having trouble understanding, the problem may be that you insist on thinking of economics as zero-sum.  This is the fallacy of 18th century mercantilists, who saw the economy as a big fixed tank, and if more flowed overseas than flowed back, the tank level would fall until the country was bankrupt.  There are at least two key fallacies here:

1. Wealth is not zero-sum.  It is created.  It is expanded.  Some can even be spent frivolously on big ass plasma TV's from China and we are still wealthier than we were decades ago.
2. Trading has value in both directions.  As mentioned above, looking at only the currency side of trading misses a lot.  By definition, in a free trade, both sides believe the trade increases the value to themselves, or they would not have made the trade.  So trading per se, no matter what the currency flows, can only lead to wealth creation, not its destruction.

Postscript - New Mercantilism

Lamenting the trade deficit is always a precursor to interfering with free trade.  It is important to note that free trade has always led to prosperity, while protectionism has always led to stagnation. 

Several protectionists today are trying to make the argument that OK, that might have been true in the past, but today is different, and today, free trade is uniquely bad.  Economist Paul Craig Roberts made this argument, that, as Don Boudreaux summarizes it:

the American standard of living is threatened by the world's growing
prosperity, improved education, better governance, and greater fluidity
of capital and resources to move in search of higher returns

Boudreaux, a writer at the fabulous Cafe Hayek, does a good fisking of this argument, but I think I can demolish it even faster.  By this logic, California would be better off if the eastern part of the US was suddenly impoverished and made educationally backwards.  This is absurd.   Sure, the industrial east suffered some temporary dislocations as the south modernized and competed for factories.  But this was only temporarily.  As the south got richer, it wasn't a contest between regions for a fixed number of factories, the number of factories and jobs grew, so that all parts of the country had more. 

Is there anyone who thinks that half of the US would be better off
economically if the other half were turned into a third world nation?  Is there any company executive that thinks they could survive if half their market went away?  So why is half the world better off if the other half is impoverished?  If you are saying, gee, the only reason I can come up with is that zero-sum fallacy Coyote keeps talking about, go to the head of the class.

Update:  In comments and emails, my readership educates me that citizens of German and Italian decent were interned in WWII as well.  While I knew that Germans and Italian POW's were interned in large numbers in the US in WWII, I was not aware of internship of US citizens with German or Italian blood, though the programs for these nationals do seem more limited than the west coast movement of Americans of Japanese decent.   My first and second generation German immigrant family members never reported being harassed in any way, either publicly or privately, during the war and most all served either in the US military or war production industries.  I will still stick by my core point that investment in the US by Asian nationals is not treated the same as investment by European or Canadian nationals.

I have also gotten a number of emails and comments on the differences between various trade and current account deficit indicators.  I tried to avoid getting into all that, assuming, I think rightly, that it would just clutter up the argument and would not substantially affect the conclusion.  Just for the record, though, there are many different metrics, that range from narrow measures of manufactured goods flows to much broader measures of capital and services flow.  You can assume that 90% of the time, the media article you are reading about the deficit probably does not correctly describe the metric it is using.

As a followup to this post on security as a Trojan horse for protectionism, I wanted to link this article in the WSJ($) called The Perils of Protectionism:

Fifty-six percent of the economists polled in the latest WSJ.com
forecasting survey -- conducted in the aftermath of a flap over foreign
management of U.S. ports -- say protectionism will lead to some
slowdown in U.S. growth over the next several years, and 8% predict
that the slowdown will be significant....

The ports controversy came at a time of growing concern about
protectionism around the world. It followed the blocked bid by China's
Cnooc Ltd. to acquire Unocal Corp. last year and emerged as European
governments angle to prevent high-profile utility deals within their
borders. The fear is that if governments take steps to shield their
countries' businesses, international trade and investment flows could
be reduced. Corporations will find it more difficult to reach new
markets.

Protectionism is unambiguously bad," said David Berson, chief economist
at Fannie Mae. Indeed, the free flow of capital across national borders
is conventionally looked upon by economists as a long-term good, and
69% of those surveyed say foreign ownership of U.S. assets is positive
for the economy in the long run.

One example of why the protectionist arguments are short-sighted is demonstrated by this passage from the same WSJ article:

While the ports row has receded, the U.S.'s large bilateral trade
deficit with China, which was $17.91 billion in January, remains a
flashpoint. Some lawmakers complain the imbalance has been inflamed by
an artifically low exchange rate for China's yuan against the dollar.
Though Beijing modestly revalued the yuan last summer, allowing it to
float in a narrow range against a basket of foreign currencies, critics
have continued to lash China's currency policy and call for further
revaluation.

So the Chinese government is artificially subsidizing the US economy through reduced prices of Chinese goods via a low valuation for the yuan vs. the dollar.  And that's a bad thing?  If the Chinese government is holding down the exchange rate, then they are in fact taking their money and the money of their citizens and pumping it into lower prices for US consumers and lower interest rates on US government debt.  Ooooh, color me really concerned.

As far as the "well, we're going into debt to pay for our consumerism" argument, I and others have tried and tried to educate the world that the trade deficit is not a debt, and running a trade deficit is not bad.

After you finish this post, I have an updated post on the same topic here.

Well, the US trade deficit is up again, and you can be sure the news was accompanied by a lot of moaning and groaning and soul-searching.  The main reason that all the media and the majority of Americans freak out over large trade deficit numbers is that they look at the American economy as a large bank vault with a fixed supply of money on the shelves.  They reason that if more money is going out of the vault to buy things than is going back in from sales, then eventually the vault will go empty and we will be bankrupt.  Either implicitly or explicitly, those who fear trade deficits perceive the trade imbalance to be red ink, something bleeding out of a fixed supply.

This view of the trade deficit as a being a growing and unsustainable debt is wrong.  I will try to explain in a couple of ways.

The micro view

Lets first look at it from the perspective on one individual.  Lets say Fred made $50,000 this year, and lives in a US where, before he makes his spending decisions, trade is exactly in balance with China.  Fred spends some of his income on rent, and invests some in some nice US equities.  And he takes $1000 of what he just made that he might have saved and buys himself a nice Chinese-made plasma TV so he can really enjoy the Superbowl next year.

So, where's the debt?  One can argue that net savings is lower (perhaps - we haven't gotten yet to where the Chinese are spending their extra US dollars), but Fred seems to have increased the trade deficit without incurring any debt.  In fact, Fred is actually better off, since in a free society no one engages in a transaction that doesn't return more value than one spends.  In this case, the plasma TV provides more than $1000 of value back to Fred, or else he would not have engaged in the transaction. 

Yes, many people are buying Chinese TV's with consumer debt, but these same people are buying much more American stuff with consumer debt as well.  To the extent that there is or is not a "problem" with people taking on too much consumer debt, this problem is absolutely unrelated to the country of origin of the goods they are buying.  You can max out your Visa card on American stuff just as easily as on Chinese stuff.

But wait, you say.  The reason the debt is not obvious is from the way I structured the problem.  I assumed the rest of the economy was static while Fred was making his decision.  But if Fred had bought American, somewhere in the US economy there must have been less debt.  So we will tackle this next.

The Economy is Not Zero Sum

Repeat please:  The economy is not zero-sum.  Never has it been so hard to convince people of a concept that should be so obvious.  I used up bushels of electrons explaining why the economy is not zero sum here, but the short proof is easy:  Look at the world in 1900.  Look at it today.  The world as a whole and most every individual is far richer.  The fact is that economies create wealth every day, and free economies create a LOT of wealth.

At the heart of every argument that the trade deficit is bad is the mercantilist notion that the US economy is a bank vault leaking funds.  But this analogy that seems to be in everyone's head is flawed.  The supply of money or wealth in the US, in the vault, is constantly growing.  If you really have to think of it as a vault, then think of what's inside as rabbits rather than gold bars.  Does anyone doubt that if you start with a hundred rabbits and every year sent a few to China that you might still have more rabbits than you started with in the vault?  A free economy is like a group of rabbits on Viagra.  Even if the Chinese took billions of dollars they got from selling goods to the US each year and burned the money in a big bonfire, the US still would be growing in wealth.

Of course, the vault analogy sucks for a larger reason, that the US economy is deeply integrated with that of the rest of the world.  In fact, much of the wealth creation comes from this very integration, providing a more robust division of labor and a deeper well of creativity and entrepreneurship than any one country could achieve on its own.  And the dollars we send overseas don't stay there, they come back.  But we will address this next.

So What do the Chinese do with Those Dollars?

OK, so we are all short-sitedly (at least according the the "progressive" intelligentsia) sending dollars to China to satisfy our consumerism.  So what do those Chinese do with those dollars?  They can't spend them domestically, because stores and vendors in China don't accept dollars any more than the Wal-mart down the street from me accepts Yuan.

Most all the dollars have to come back to the US, or the person in China holding them gets no value.  You could say, well that person can take them to the bank and exchange them for Yuan, and that is true.  But that bank would not accept the dollars for exchange unless it knew it could get them back to the US, or had another client that needed them to make a purchase in the US.  So, the dollars will have to come back to the US to purchase something.

Some of the dollars come back to purchase US goods and raw materials, but of course this is less than the total dollars the Chinese have to spend, or else there would be no trade deficit.  In fact, this all that the words "trade deficit" really means.  It means that of the dollars the Chinese receive from sales to the US, only a portion is used to buy American goods that are shipped back to China.  The rest goes to buy American .. something else.

What?

Well, some of it goes to purchase American goods that stay in the US.  Lets shamelessly steal an analogy from Don Beadreaux and Jack Wenders.  If Chinese companies buy American steel and lumber and ship it to China, it shows up in the trade balance.  If they buy the same products and build a factory in the US, it does not.  The Chinese use a lot of their dollars to invest in buildings, real estate, capital assets, factories, production facilities, etc. in the US.  And this is bad, how?  I know that since the Japanese investment boom of the eighties, there are lots of folks who call themselves "liberal" who suddenly got very upset about foreigners owning US-based assets.  It is impossible for me to see this concern as anything but xenophobia and racism, since hundreds of years of Dutch, Canadian, and British investment never worried a soul but Japanese and Chinese investment has everyone in a lather. 

By the way, if you worry about China as a security threat, wouldn't you rather see them invested in the US economy, and therefore have a strong interest in our continued prosperity?  One could easily wonder why Saudi Arabia does not use their power over oil reserves to screw with the US like they tried to do in the early 70's.  The reason is that all of their wealth is invested in dollar and euro-denomitated assets.   People worry about the power the Saudis may have to mess with our economy, but their reinvestment of dollars back in our economy has made this a game of mutual assured destruction.  The same thing is occuring with China.

The other thing the Chinese do with the money is invest in dollar-denominated financial assets, which in many ways is just an indirect way of investing in the same capital assets listed above.  They will invest dollars in equities and, yes, debt securities.  But the fact that the Chinese choose to spend their dollars on debt securities does not mean that the trade deficit is causing the debt.  If the Chinese had a predilection for debt securities, more so than say an American holder of dollars, one might argue that this predilection drives down interest rates a bit and therefore might increase total debt, but this is a fairly tenuous chain of causation and not, I think, what seems to be bothering folks who panic over the trade deficit.  In fact, one can argue that the causation runs more strongly the other direction, that the large US budget deficit keeps the dollar higher than it might otherwise be, increasing the trade deficit.

So when people lament that "we now consume much more than we produce", they are making a meaningless statement because the we in the first part are not the same as the we in the second part.  The US and the Chinese are sending equal amounts of money back and forth - its has to be, over the medium to long term, or exchange rates would crash.  All the trade deficit means is that there is a difference in WHERE Chinese and Americans consume the goods.  Americans consume Chinese goods in the US.  The Chinese consume some of the US goods it buys in China, and then consumes the rest in the US.  The trade deficit represents the net amount of American goods and services the Chinese buy in the US and choose not to haul back to China.  Instead, they take ownership of the American goods here, in the form of capital assets or financial securities that represent ownership or calls on the cash flow of these capital assets. 

Anyway, you can find more here at Cafe Hayek.

Postscript:  By the way, the US has run a trade deficit of a magnitude that panics people for over two decades.  If this is bad, surely we would be able to find the damage somewhere.  But the US over the last two decades has had the strongest economy in the world.  I suspect that a lot of people would answer "we have run up a huge debt".  But any increase in total debt in the US is not relevant to the trade deficit, or only tangentially related as discussed above.  The Federal debt is run up because the politicians are all spending whores who support their reelection with "good works" paid for with our money.  Consumer debt, which may or may not be "too high", is based on individual spending and saving choices, and is unaffected by whether a person buys an American or Chinese TV.