The Distraction of the Balance of Payments

On Tuesday, February 27th The Bulletin’s Joe Murray reported on lobbying efforts to end the president’s “Fast Track” trade authority. Organizations such as the United States Business and Industry Council (USBIC) are leading the charge to end the worldwide free trade effort that has characterized international relations since the end of World War II. These organizations claim that free trade has harmed America’s “Main Street”, a euphemism adopted by the USBIC. In calling for an end to free trade (just Google the USBIC and read the laundry list of desired government interventions from sixty percent tariffs on any country that manipulates is currency to scaling back on LEGAL (!) emigration) the USBIC points to the large U.S. balance of payments deficit as an indicator of the damage to our economy from free trade. I doubt that anyone at the USBIC understands much about international balance of payments except that it can be useful in manipulating public opinion into adopting policies beneficial to its members’ interests even if adverse to those of the rest of us.

Let me first address the issue of linking a nation’s trade deficit (or surplus) with the idea that the former is bad and the latter good. First of all, it is impossible for ALL nations to hold trade surpluses, since this could happen only if the nations of the world traded with Martians or if international trade were banned altogether. Secondly, it is not true that a trade deficit always or even primarily means that a nation is buying more than it sells abroad. The trade deficit is a statistical construct encompassing flows of goods, services, capital, and debt, among other financial data. It is not the same as an individual, a firm, or our government going into debt. A country’s economic health is independent of its balance of payments. A nation can go into recession when it has a positive balance of payments and when it has a negative balance of payments. A nation’s economic health is measured primarily by whether or not its citizens can acquire the goods and services that they desire at the lowest cost in the market.

The Barrons Suffer a Balance of Payments Deficit

It can be said that the Barron household has a trade deficit with just about everyone in our hometown. We buy haircuts, groceries, cleaning services, restaurant meals, videos, gasoline…you name it…and none of these establishments buy anything from us. At one time, when the Barron household was young, it had a huge balance of payments surplus with the world at large, because it had borrowed money for the purchase of our home–the mortgage lender bought our debt. Was this a good thing for the Barron household or a bad thing? Well, it was neither good nor bad. The home mortgage lender made a judgment, correctly as it turns out, that the Barrons were likely to pay back the debt, which we did. The lender’s action of buying our debt gave us a temporary balance of payments surplus. But as we paid it back over time, we experienced a gradual balance of payments deficit. If we had failed to pay back the loan, we would not have suffered a gradual negative balance of payments vis a vis our home mortgage lender. But that does not mean that it would have been a good thing, because we would have had a hard time getting credit anywhere else for quite awhile.

The same is true of international balance of payments, which is nothing more than a statistical construct of millions, perhaps billions, or private transactions among the private citizens of many nations of the world with one another. The private parties to it evaluate each transaction. They may evaluate correctly or incorrectly. But each party expects to gain from the transaction, which just happens to involve parties from different countries. It makes no difference that the transaction crosses international borders, state borders, county borders, or with a next door neighbor.

A Nation Cannot Gain by Manipulating Its Currency

Next let me address the claim that the Chinese benefit by holding their currency at roughly a third of its free exchange value. It is clear that the Chinese are doing this, but is it a good thing for the Chinese or a bad thing? If it helps the Chinese, as the USBIC claims, then why don’t we hold our currency at half its free market value? Then maybe the Chinese will go one up and hold their currency at three-fourths the free market value! Then we can make our currency free! The answer is obvious. No nation can become wealthy by manipulating its own currency. All it can do is cause some special interest groups within its monopolized currency area to gain at the expense of all others within its monopolized currency area. In the case of China, the owners and employees of export oriented manufacturers (who just happen to be Red Army and Communist Party bigwigs) gain at the expense of the rest of the teeming Chinese masses. By holding its currency cheap, the Chinese are causing inflation inside China, the burden of this inflation being shouldered by those who have little or no political power. There is nothing that we can do about this. It is a problem caused by the Chinese and only internal pressure from the Chinese themselves will correct it. If the U.S. adopted such a policy–which, by the way, we have done in the past when the Fed injected excessive reserves into the economy, driving down the interest rate–inflation eventually emerges. Export oriented businesses gained at the expense of the rest of us, because their goods became more competitive internationally. But the increase in the supply of money eventually worked its way through our economy in irregular ways, causing the prices of goods to increase. Those of us who were not involved in these export-oriented industries suffered, and most people had no idea what had happened except that their dollars didn’t go as far as in the past.

Fortunately the average U.S. citizen has more political power than the average Chinaman, so eventually the political elite is forced to put an end to this inflation, at least temporarily. But the lure of an inflationary boom still beckons, despite the damage that it does.

The Japanese Lesson

The USBIC claims that U.S. businesses are harmed by these currency interventions and, I must admit, in an indirect way they are harmed. Currency manipulations by any major international trading nation cause capital to be malinvested. (The U.S. is as big a culprit as any nation.) Export oriented industries are harmed in the sense that they fail to make sales that they would have made in a free market environment. But retaliatory actions would harm all of the U.S. while failing to help the industries suffering from cheap imports. China’s Mercantilist policies will not work and eventually the Chinese will be forced to abandon them, just as the Japanese did. In fact Japan is an example of the failure of the policies now followed by China. For decades Japan followed policies that aided export manufacturers at the expense of the rest of the Japanese economy. It appeared to work for a long time. But the Japanese economy has been stagnating for almost two decades, all a result of malinvestment that cannot be undone.

Subsidizing a Lawn Mowing Service

A few years ago my friend’s son wanted to get into the lawn mowing business. He went to his father, who made him a gift of a large, industrial-sized mower plus a trailer to transport it from job to job. My friend’s son solicited the business of friends and acquaintances and offered to perform lawn-mowing services below the price currently charged by those in the business. He got lots of customers. At the end of the second year, the mower was worn out. The young man went to his father and asked him to buy him a new mower. The father asked him why he had not saved enough to replace the first one, which he received as a gift. Of course, the young man had not charged enough to produce enough savings to buy a new machine. That was the end of his lawn mowing business. Now, my original mowing service was harmed indirectly when I switched my patronage to my friend’s son. Its revenue went down. Perhaps the owner was forced to lay off men. I don’t know. But I am back with them now. In the meantime, I enjoyed savings from cheaper lawn mowing services, made possible by my friend, who gave his son the mower and trailer.

I doubt that the USBIC and the manufacturers of America will be encouraged by this example of a slow market correction, but it is the only peaceful means available. I suppose my old lawn-mowing firm could have gone to my township government and asked them make it unlawful for me to hire anyone else, perhaps pointing out the “illegal subsidy” of my friend’s mower to his son. In that case, I would have been at the mercy of whatever prices my lawn mowing service wanted to charge. Or my township could have gone to my friend and asked him to refrain from subsidizing his son’s new business, but it is as unlikely that my friend would so oblige my township government as that the Chinese will oblige U.S. diplomats’ entreaties to refrain from intervening in their own currency markets. I’m sure my friend would tell my township government to mind its own business, just as the Chinese are telling U.S. diplomats the same thing in much more polite language. We can only be reassured that internal pressures from both sources drove these market interventions in the first place and only internal pressures will end them.

Get Our Own House in Order

The balance of payments position of any nation is not an accurate indicator of the health of an economy. Intervention to restrict international trade will have little effect on this statistical construct and will only cause damage to the nations so affected. Those who decry the lack of competitiveness of American industry must look internally for its causes. Excessive regulation, high taxes, legal barriers to market entry, restrictive labor laws, unnecessary licensing, plus the burden of government reporting adds unnecessary cost to American products. It may be true that countries manipulate their currency to benefit export industries, but there is nothing that we can do about it and eventually those countries will recognize the error of their ways. Obsessing on our trading partners’ internal policies is a waste of time and detracts us from taking our own positive steps to free our economy so that our companies can better compete in the world.