Trade Deficits are a Bad Thing

Economics Economics Questions
1

I’m a big fan of Peter Schiff’s and one thing I found interesting was his assertion that trade deficits are a bad thing, a sign that your country is not productive. I’ve always heard from free market economists that there is nothing wrong with trade deficits. After further review I have to agree with Schiff, I think chronic trade deficits are bad. Unlike protectionists however I believe the cure is for less government spending and regulation. I think trade deficits are a sign that your government has become overly intrusive on business. I would never be in favor of any tariffs or anything similar.

The following is an except from Peter Schiff’s book, Crash Proof. I think it is an excellent explanation why trade deficits are bad:

Tale of Two Farmers

Farmer Chang only grows oranges. Farmer Jones only grows apples. Each grows only the fruit that he produces most efficiently, trading the surplus for the fruit grown by the other. Both farmers benefit from comparative advantage and free trade. The sole reason that Farmer Chang “exports” oranges is to “import” apples, and vise-versa.

Suppose that one year a frost wipes out farmer Jones’ apple crop. Not having any fruit to trade, but hungry nevertheless, he proposes to trade apple IOUs for farmer Chang’s oranges. Since Farmer Chang cannot eat all of the oranges he grew anyway, and since farmer Jones’ IOUs will pay 10% interest (in extra apples of course) he agrees.

Farmer Chang only accepts farmer Jones’ offer because of the apples that Farmer Jones’ IOUs promise to pay. By themselves, the IOUs have no intrinsic value. Farmer Chang cannot eat them. It is only the promise to pay apples that gives them value.

Now suppose that the following year farmer Jones’ crop is again destroyed, this time by a flood. He and Farmer Chang once again make the same deal, with Farmer Jones getting more of Farmer Chang’s oranges, and Farmer Chang accepting more of Farmer Jones’ IOUs.

Further suppose that similar natural disasters continue to besiege Farmer Jones for several more years, with Farmer Chang continuing to accept Farmer Jones’ interest-bearing apple IOUs in exchange for his oranges. Eventually it dawns on Farmer Jones that he is eating pretty well, without actually farming. He therefore decides to turn his apple orchard into a golf course, and simply play golf all day while enjoying Farmer Chang’s oranges. In other words, Farmer Jones now operates a “service economy.”

Farmer Chang on the other hand is so busy growing all those oranges that he never gets a chance to play Farmer Jones’ course. In fact, he has been accepting farmer Jones’s IOUs for so long that he no longer remembers his original reason for doing so. He forgot about his original desire to actually eat the real apples Farmer Jones had promised to deliver. Instead, he now counts his wealth based solely on his accumulation of apple IOUs.

In fact, Farmer Jones had such a good reputation within the farming community that Farmer Chang was actually able to trade some of Farmer Jones’ IOUs for goods and services provided by other farmers and local merchants. Apparently no one bothered to notice that Farmer Jones’ apple orchard had become a golf course, and that his IOUs were therefore worthless, as he no longer possessed the ability to redeem them with actual apples.

Some might argue that the entire community now depends on Farmer Jones and his worthless IOUs and that everyone will accept them indifferently rather than acknowledging the reality of their folly. Of course, were these revelations to occur, any unfortunate holders of Farmer Jones’ IOUs would officially be forced to realize their losses. However, their true financial situations would improve, as any further accumulation of worthless IOUs would end. As for Farmer Chang, he would literally once again enjoy all of the fruits of his labor.

The real loser of course would be Farmer Jones, for without a viable apple orchard or the ability to buy oranges on credit, he would starve. It would take years to transform his golf course back into an orchard, regain his lost knowledge of farming, and replace his obsolete or dilapidated farming equipment (provided he hadn’t already traded it in for golf carts and titanium clubs). In the end, his only alternative might be to sell his golf course to farmer Chang and take a job picking fruit in his orange grove.

2

The problem is not the deficit per se but how the deficit has come about; By foreigners buying US government securities with the cash they receive from Americans, they have enabled the american consumer to have greater purchasing power in terms of imported goods then he would have had if no such demand for US securities existed. So if you believe that government debt will never get repaid, then it is obvious that consumers have enjoyed a higher standard of living without the usual sacrifice, i.e, saving and production. Foreigners have effectively subsidized the American consumer.

I can’t realy know what Schiff means when he’s talking about the deficit. He’s unclear about this issue. But clearly, the a deficit is a statist concept based on mercantilistic economics.

3

What if the deficit came about from printing money? Or from borrowing from US citizens? Wouldn’t that still be bad? What would be an example of a deficit not being a problem?

4

We’re talking about the international trade deficit, right? not government budget deficit.

Again, trade deficit is arbitrarily defined. It stems from the fallacy that real physical goods must be exchanged for real physical goods. This is nonsense. Any voluntary exchange is a good exchange that both parties expect to profit from.

If the Chinese people for example want to hold on to American dollars and not spend them, that is their choice. They see value in holding dollars.

If they want to “invest” in US securities because they believe in the invincible US empire, then that is also their choice according to their own value judgement.

Too bad for government statisticians who don’t count such action as part of the trade.

5

OK, take off your Morality hat and put on your Investor hat. Would you be at all concerned in investing in a country that has been running a large trade deficit over a long period of time? Isn’t that a sign that the country’s productive capacity is poor? And isn’t productive capacity important in Austrian theory?

This whole trade deficit thing is very interesting to me. Look at it another way. Suppose a family is running their own little trade deficit. Suppose they had no income and borrowed $100K and used it to buy stuff. This would be a mini-trade deficit since they are not trading something they produced. Wouldn’t this be a sign that their productivity is poor? And don’t Austrians believe that economic theory is essentially the same for an individual or small group as it is for a large group or country?

6

How are you defining the idea of a trade deficit? Do you mean in monetary terms? How is a trade deficit possible? The trade deficit requires a zero-sum game, because it inherently assumes that Person B who gave Person A $100 in exchange for Product X is now in deficit. This is not true, as person B garners greater utility from Product X than from the $100 he paid for it. Or, do you consider the entrepreneur who paid $1,000 for a capital-good to be in a trade deficit, or do you consider him unproductive? Clearly, the capital-good is more conducive to wealth creation than the $1,000.

Relevant to modern macroeconomics, the only important part of a trade deficit is when the government itself is in deficit and is borrowing money, or monetary controls cause a large amount of investors to gather private debt. But, otherwise the idea of a trade deficit is unworthy of special attention.

7

How about trading fiat currency for actual goods?

8

lucky for some

9

Best deal we could ever get. As Milton Friedman use to say, we can print all the green pieces of paper they could ever want.

10

What’s the difference? The goods are still garnering higher utility than the money substitute being paid for it. Both partners are gaining utility, otherwise the trade would not have happened.

11

This is true but only so far as it goes. I have a trade deficit with the grocery store, for example. I make up this deficit by selling my services in turn to get money to buy groceries. Or, I get the grocery store to extend credit which I use to leverage my activities and generate a profit down the road. So a trade deficit is an incomplete picture; it doesn’t (AFAIK) show how the rest of the world ships dollars back for investment in US companies. But at the end of the day the books have to balance: you must produce an amount of goods and services that are at least equal to your consumption. I don’t think the US is doing that; we’re making up the difference by inflation and credit. Eventually, the rest of the world will stop selling us stuff at prices we can afford out of our production.

12

I think that this is misleading. The pizza you bought at the grocery store had greater utility than the $10 you paid for it. You got more out of eating that pizza than what you could have done with those $10. There is no trade deficit represented in that transaction. Yes, in order to consume you must produce, but that is really outside of the scope of the concept of the trade deficit.

What is occurring in the United States is not a product of a trade deficit per sé. It is a product of investment and trade fueled by inflation, and government allocation and waste of capital. When talking about the concept of a trade deficit, and only the concept, a trade deficit is not technically possible because both parties have gained from the exchange. A deficit would imply that you’ve lost. It’s true that usually trade, in national currencies, does balance, because a Chinese person holding U.S. dollars can’t spend that money outside of the U.S. economy, but otherwise this is just a question of productivity. All considered, there should be no balance, but a gain in wealth.

13

You have a good analysis Jonathan, to help you cut through to the other side I will merely suggest that passionate talk of trade deficits always makes implicit ‘accounted in dollars’ judgements.

14

I agree. In the grocery store example I trade dollars for food, the grocery store trades those dollars for electricity and the electricity company trades those dolars for my labor, thus completing the cycle.

A more accurate example would be if I am buying the food with counterfeit money from my printing press. In the short term I’m getting a great deal but what happens when they find out?