Trade Deficits

on Tuesday, October 4, 2011

Don Boudreaux writes that trade deficits are irrelevant, both because of the way they are calculated, and additionally, because dollars must always eventually return to the United States, to purchase goods and services from US producers.

He correct in stating that deficits are of no concern to the well being of Americans, but is wrong in assuming that US dollars must always eventually purchase US goods or services. Dollars may be circulated indefinitely without enjoying the ownership of an American citizen ever again. Some nations use them as national currency, others use them as central-bank reserves, and foreign individuals may hold them as investments, trading them back and forth, indefinitely absent of American ownership.

Further, Mr. Boudreaux assumes that when American buys something from China using dollars, that those dollars are not immediately traded for Chinese currency on the forex.

And finally, Americans are the primary debtors to US banks, and are therefore, as a group, more negatively affected by deflationary pressure on US dollars. The supply of dollars is made lower if they are held in foreign bank accounts, because US banks no longer include them in the reserve calculations used to create new dollars. The citizenship of the dollar’s owner is always irrelevant — it is only the citizenship of the bank that matters to Americans.

The reality is likely that dollars are either quickly repatriated using currency exchanges, or that foreign companies hold accounts with US banks, and payments are accepted in dollars that never leave the United States banking system.

Much of the trouble in visualizing the impact of foreign trade is borne of a failure to regard dollars as a form of wealth, with an intrinsic value to those that must ultimately consume them. Dollars are born when banks issue new loans, and are consumed when those loans are repaid, in the same way that wine is created  in when grapes are fermented and destroyed when poured at the dinner table. Wine has value for the same reason as any paper currency, and both are created and destroyed in ongoing cycles. There is no such thing as "intrinsic value," or "real value," or "use value." All are childlike concepts invented to legitimize or quantify the reasons that any object is valuable. To avoid the truth -- that any object has value only because someone values it, is a grave error.