Profile image
By Cafe Hayek (Reporter)
Contributor profile | More stories
Story Views

Last Hour:
Last 24 Hours:

On Some Misunderstandings of the ‘Balance of Trade’

Friday, October 28, 2016 7:57
% of readers think this story is Fact. Add your two cents.

(Don Boudreaux)


Responding to this Cafe Hayek post, a regular reader e-mails the following to me:

1 – I have never heard of Trump or anyone being against a Chinese or Japanese investing their money IN the US – he complains about a Chinese glass factory IN China exporting to the US especially if the exchange is subsidized. – I am not in favor of his position but do not think it is quite what you write.

2 – the two situations are not comparable either – the US fellow is investing US dollars in the US – The Chinese fellow has to convert yuan into dollars before investing in the US – a big positive for us. He not only soaks up some of the trade balance to get the dollars but then uses them to increase American employment rather than Chinese employment at home.

This reader is mistaken, but his error is forgivable given the swirl of confusions that engulf discussions of trade and so-called ‘trade balances.’  Here’s is my (edited, expanded, and grammatically corrected) reply to him:

Whenever Trump and others complain about the U.S. trade deficit they are necessarily complaining about foreigners investing in the U.S. or in dollar-denominated assets.  The fact that Trump and other such complainers do not understand that they are complaining about foreigners investing in the U.S. or in dollar-denominated assets does not change the economic reality.  Every cent of the U.S. trade deficit – or, more accurately, every cent of the U.S. current-account deficit – is offset by a cent in the U.S. capital-account surplus.

As for your second point, in both examples in my original post it is U.S. dollars that are invested in the U.S. (that is, in the Ohio glass-making factory).  The details of how the Chinese entrepreneur who actually carries out this investment got those dollars are immaterial (assuming, of course, that it was through peaceful commerce).  The Chinese entrepreneur might well have gotten most, or even all, of those dollars in exactly the same way that the American is assumed to have gotten those dollars: by selling outputs to Americans who paid for those outputs using U.S. dollars.

But even if Mr. Cho, the Chinese entrepreneur, got all of his dollars by converting yuan into them, then the person who sold to him the dollars had to get those dollars from somewhere – and they were, at some point, gotten by the sale of Chinese exports to Americans or by Chinese earnings on investments in dollar-denominated assets (which assets were bought with U.S. dollars gotten originally from the sale of exports to Americans).  The fact that the specific dollars in question might perhaps have been initially earned by some other Chinese individuals and then sold (for yuan) to Mr. Cho does nothing whatsoever to alter the economics of the situation: in both cases – the American building the glass-producing factory in Ohio, or the Chinese person building that factory – the economic consequences for Americans are identical.

By the way, it’s incorrect to say that the Chinese entrepreneur who, in order to get dollars to invest in America converts yuan to dollars, “soaks up some of the trade balance.”  In fact he does no such thing if he invests all of those dollars in the Ohio factory.  Because foreign direct investments in the U.S. are recorded on the capital account just as are foreign holdings of U.S. dollars, the trade balance is unchanged if this investment occurs compared to if the previous Chinese owner of those dollars simply stuffed them into his mattress in Shanghai.

Yet your belief that Mr. Cho’s purchase of dollars with yuan “soaks up” of some of the U.S. trade deficit reveals an understandable misconception, but a misconception nevertheless – namely, that the U.S. trade deficit is consists only of funds withdrawn from the U.S. economy and not returned to it either as demand for U.S. exports or as investments in the U.S.  In fact, and as alluded to earlier, the U.S. trade (current-account) deficit rises whenever foreigners ‘return’ dollars to the U.S. on the U.S. capital account – which include foreigners’ investing, in whatever ways (passively or actively) in U.S.-based equity (such as the factory in Ohio, or buying a single share of Apple stock from an American), foreigners lending funds to Americans (including to the U.S. government), foreigners purchasing real estate in America, and foreigners simply holding Federal Reserve Notes.

Some of the complaint about the U.S. trade deficit is that much of it is converted into debt owed to the U.S. Treasury.  While I share concerns about Uncle Sam’s profligate borrowing, (1) I do not care what are the nationalities of the creditors, for that is irrelevant, and (2) the problem is Uncle Sam’s fiscal profligacy and not trade policy or American-consumers’ profligacy.  Another source of misguided worry about the U.S. trade deficit is that foreigners simply hoard large piles of Federal Reserve Notes.  If and to the extent such hoarding occurs, that is the best of all possible outcomes for us Americans, for it means that we get valuable goods and services from foreigners in exchange for mere pieces of paper smeared with green and black ink and featuring nothing but corny drawings, the signatures of some American mandarins, and monochrome portraits of dead American statesmen.

Don Boudreaux

Adam Smith’s wisdom warrants repetition here: “Nothing, however, can be more absurd than this whole doctrine of the balance of trade.”


We encourage you to Share our Reports, Analyses, Breaking News and Videos. Simply Click your Favorite Social Media Button and Share.

Report abuse


Your Comments
Question   Razz  Sad   Evil  Exclaim  Smile  Redface  Biggrin  Surprised  Eek   Confused   Cool  LOL   Mad   Twisted  Rolleyes   Wink  Idea  Arrow  Neutral  Cry   Mr. Green

Top Stories
Recent Stories



Top Global

Top Alternative



Email this story
Email this story

If you really want to ban this commenter, please write down the reason:

If you really want to disable all recommended stories, click on OK button. After that, you will be redirect to your options page.