Minyan Mailbag: The Trade Deficit
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. We share this next column with that very intent.
May we discuss the trade deficit in isolation for a moment?
When governments made the decision to reduce trade barriers, a change in trade balances became inevitable. The richest pool of consumers was clearly going to continue to consume. The trade deficit measures trade not between governments, but between consumers and suppliers. Only to the slightest degree is it a government problem.
If I purchase an item from a Japanese firm, and create a liability, why is this so much more worrisome than borrowing money from a U.S. citizen of Japanese ancestry in San Francisco?
To clear up the problem of debt owed to foreigners, all we have to do is change the immigration laws, and let the Japanese lender become a U.S. citizen. BINGO! Problem solved.
What am I missing here? Comments?
The liability still exists, albeit from being owed to the U.S. taxpayer in the past to a foreign investor now. In the example of the Japanese lender below, if using the Japanese ownership of over U.S.$850 billion in U.S. bonds, the Japanese lender still expects to be paid, otherwise rational economic thought would eventually force the investor to consider liquidating the U.S. bonds and U.S. dollars.
It is the growth in liabilities (credit) past supporting productive assets that is at the heart of the matter. Who owns that credit is a sideshow; the sideshow, however, could prove very dangerous. The Europeans have not "played along" as the Asians have and that is why we are beginning to see trade/tariff rumblings.
The currency is one mechanism by which a trade imbalance is corrected. In the example of a Japanese lender becoming a U.S. citizen, the correction of the imbalance could take the form of a U.S. citizen default, and the Japanese lender seizing assets collateralized by the U.S. bonds (i.e. full faith & power etc.). We go from (in the past) an internal imbalance which can be corrected by increasing taxes to an external one where the imbalance must be corrected through currency flows.
It is not the consumption of the richest pool of consumers in and of itself that is at issue, it is the means by which such consumption is financed and the degree to which foreigners are willing to build up their holdings of U.S. dollars/dollar assets. As the financing of such consumption has largely been credit-based (i.e. debt/gdp), foreigners have had to make the decision to either accept such credit and protect their export industries, or demand a risk-premium for such credit (i.e. higher interest rates) and let their currencies appreciate. To date, foreigners have largely continued to accumulate U.S. dollar assets, and as such the U.S. continues to build up external liabilities. Of course, the U.S. could monetize this debt via printing of U.S. dollars; however, the U.S. dollar would likely plummet and its role as a reserve currency would be abandoned .
I apologize that I did not make myself clear. I was trying to view the trade deficit in isolation, and particularly as distinct from the U.S. Budget deficit. It seems to me that the trade deficit is owed consumer to supplier - it is a commercial debt. The Budget deficit is owed to whom ever cares to buy government paper.
One is, say Wal-Mart (WMT) to Sony (SNE), the other is the U.S. government to who ever holds the Treasury paper.
So what I am staring at, is a situation where Wal-Mart has a bill from Sony. It sells the item it purchased to a U.S. consumer, and pays Sony (Sony can set the terms of payment in Dollars, Yen or Shekels). The fact that there are more purchases than sales does not seem remarkable; rather, it seems an inevitable result of the change in trade patterns after trade barriers (tariffs) have been removed.
I am thinking this should be distinguished from a Budget Deficit where the government spends more than it receives, and can only deal with the resultant issue by raising taxes, devaluing the dollar or raising interest rates all of which have significant consequences.
I am trying, poorly, to make the case that this should be two separate conversations. The trade deficit and the budget deficit are created by two different causes (commerce and government), and are subject to different solutions. That is, if, in fact, the trade numbers are really an issue -- but, let's save that for another time.
By trying to separate the "twin deficits", am I missing something? Please know that your thoughts are much appreciated.
This is not true. The U.S. consumer buys from Sony; Sony takes the dollars and sells them to BOJ and BOJ is holding dollars by buying U.S. financial assets. If this were not the case, the dollar would be much much lower.
This is how this time is different. Normally, a trade deficit does not have to be linked to budget deficits. Normally, a trade deficit will fix itself over time as relative currency valuations affect it.
This time the central banks have intervened in this process and kept the trade deficit growing. The U.S. consumer could not continue at the current pace if the U.S. and Asian central banks together did not continue to issue more and more credit and defacto buy that credit themselves.
This is what at least two economists, Stephen Roach and Paul Volker, are up in arms about.
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