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Source link: http://archive.mises.org/6168/isnt-the-capital-surplus-a-good-thing/

Isn’t the Capital Surplus a Good Thing?

January 22, 2007 by

The man on the street passionately believes that we ought to sell more stuff to foreigners than we buy from them. But he also believes quite strongly that it’s good if foreign companies build factories here, rather than Americans exporting capital abroad. So when we free market economists point out that the two positions are mutually exclusive, that at least causes the protectionist to scratch his head. Remember: a positive trade deficit must yield a positive capital account surplus, i.e., a net inflow of foreign investment in US assets. FULL ARTICLE

{ 157 comments }

Alex MacMillan January 24, 2007 at 3:28 pm

RogerM:

Well, Roger here is where I suppose we’re going to agree. I’m sure you meant to say “real per capita GNP is the best proxy [for living standards]” not “real per capita GDP”. GNP subtracts from GDP a couple of things, the main one for the U.S. being net interest and dividends remitted to foreigners on the net U.S. international debt. These net interest and dividend payments, naturally, are not American income (and again, regardless who’s doing the adding up of American incomes).

However, one more time! The main issue with RPM’s article is that his saying that net foreign liabilities don’t matter since they are simply the result of market transactions that either benefit all those affected by the transactions or are at the worst benign. This statement (once more) is patently false. Net foreign liabilities matter because as you argued above, they influence future generations’ incomes.

RPM January 24, 2007 at 3:57 pm

quasibill: Eventually, the people in the region either balance their accounts, even if at a very low gross level, or they drop out of international trade and become a subsistence economy. You can’t continue spending more gold than you receive indefinitely, absent theft or discovery of unowned ore.

OK, I realize all of us have been growing testy, but please listen to what I am saying.

You guys are thinking about this the wrong way.

The way the “trade deficit” is currently defined, suppose people in an-cap country A buy a bunch of books from an-cap country B for 1000 oz. of gold. During the same period, the people in country B buy 1000 oz. worth of stock shares in companies in country A.

The net gold transfer is zero. And if there are no other transactions, country A is runs a 1000 oz. trade deficit vis-a-vis B. So as this example shows, you could run a trade deficit without reducing the amount of gold in your country.

Now the question is, can the people in one an-cap region continually sell stock or bonds or other claims on future income flows, on net, to another region? Yes, they could. In our example above, if the people used the books to train themselves to become more productive, then the total market value of the companies in the region might go up by more than 1000 oz. of gold in the period. So the books “paid for themselves.”

Especially if country A has a bunch of intelligent but ignorant workers, they could do this year after year, buying more and more books from region B, with a constant stream of trade deficits.

Again, I’m not saying this is necessarily what’s going on with the current US. But you guys need to understand what “the trade deficit” *means* before you can decide if it’s bad. We already know that central banking and fiat money are bad.

David White January 24, 2007 at 3:57 pm

RPM,

“Official” trade deficits don’t mean any more to me than the “official” inflation rate, and as mercantilism was the order of the day back then, it is to be distinguished from a true gold standard. Thus could one say, I suppose, that there were trade deficits of some kind, but more to the point:

“You’re right, the overall trade accounts _do_ balance, but that’s because a current account deficit can be offset by a capital account surplus. With two 100% an-cap regions, if the people in A are net investors vis-a-vis the people in B, then there would be a trade deficit between the two groups.”

Assuming by “investors” you mean those who spend their money to purchase foreign goods, then if the money is sound (e.g., gold), calling the result a “trade deficit” is meaningless, since (we agree that) the goods traded for balance out. Rather, a line has been artificially drawn around a particular group of people (country A), who happen to have swapped more money (gold) for other goods (shovels) than a similar group elsewhere (country B). Hence, no “trade deficit.” And as long as country A is able to produce enough wealth via savings-based production — i.e., through work — its citizens will be able to continue to purchase goods from country B, thus engaging in mutually beneficial trade that accordingly creates no deficit.

This isn’t so in today’s fiat-based world, however, where countries don’t trade with sound money. For not only do these countries have their own currencies; they have currencies that, by government edict, are “legal tender” that is not a redeemable money substitute but money itself. As such, it is a financial instrument that ipso facto creates a “deficit” for the simple reason that no work (to speak of) is involved in its creation. Thus is the purchasing power of this “work-free” money reduced the more of it is created (simple supply and demand), and thus is inflation the inevitable result.

Moreover, to export this inflation via trade with a low-wage country is to export the deficit that work-free money creates. And however wrongheaded it is to dismiss the domestic deficit (the “national debt”) as “owing it to ourselves,” it is even more wrongheaded to say that exporting the deficit to another country doesn’t matter. It DOES matter, and it matters in direct proportion to how large it is, ours being so monstrous that it represents an IMbalance the likes of which the world has never seen and that is accordingly unsustainable.

Thus did I take issue, and still do, with your “deficits don’t matter” position, defending Schiff accordingly.

RPM January 24, 2007 at 4:05 pm

David,

In the same post you just told me that “‘Official’ trade deficits don’t mean any more to me than the ‘official’ inflation rate…” and “Thus did I take issue, and still do, with your ‘deficits don’t matter’ position…”

Do you see the irony of this? The huge, allegedly unsustainable numbers are the “official trade deficit” statistics, which I say are very misleading. Then you tell me those stats are useless, and that I am wrong for denying their relevance.

Once again, I agree central banks and fiat money are bad.

Pepe January 24, 2007 at 4:49 pm

Dr. Murphy,

I see the irony.

David White January 24, 2007 at 5:17 pm

RPM,

You maintain that there were trade deficits prior to our going off the gold standard, and all I said is that insofar as a true gold standard didn’t actually exist, there could have been trade deficits to the extent that mercantilism had distorted free-market mechanisms (however paltry that distortion would have been relative to what we confront today).

In any case, the market tracks the bond trade — i.e., the purchase of the debt without which our economy would collapse — so saying that I don’t buy into the “official” numbers simply doesn’t wash.

More to the point, however, is that you had NO RESPONSE to the essence of my reply, which is (1) that fiat money causes relentless inflation, the exportation of which exports the deficit that is the essence of fiat money’s work-free nature and (2) that this deficit matters precisely because it is a Ponzi scheme that is accordingly unsustainable.

So while you may “agree that central banks and fiat money are bad,” you do the cause of freedom a disservice by defending the deficits-don’t-matter position, as it defends the status (as in statist) quo.

RogerM January 25, 2007 at 8:43 am

David: “fiat money causes relentless inflation,”

No disagreement there.

“…the exportation of which exports the deficit”

I’m not clear what you’re saying with the second part. Are you saying that the fiat money causes trade deficits, or that because of trade deficits exist, we’re able to export our inflation? Also, I’m not clear what you mean by deficit in the sentence above.

“this deficit matters precisely because it is a Ponzi scheme”

Surely you don’t mean all of the trade deficit is a result of fiat money. Murphy has tried valiantly to show that trade deficits would naturally occur, and have occurred under a pure gold standard. And he has about 200 years of economic theory to back him up. They occur because of what Ricardo called comparative advantage and they’re nothing more than the spread of the division of labor. I’m afraid he’s beating his head against a brick wall, though.

I certainly agree that some of the deficit is caused by fiat money, but probably a small part. A problem with fiat money is that it can do a lot of the same things as gold/silver, so in a lot of ways it works like real money; it just has some very bad side effects.

Under a gold standard, as Murphy, adi, Pepe, Smith, Ricardo and others have pointed out, a country whose economy is growing faster than other economies will run a high, persistent trade deficit as it borrows money from other countries to invest in new and expanded production. Such borrowing will cause that country to be richer in the future, and probably richer than those from whom it borrows.

Alex MacMillan January 25, 2007 at 9:32 am

RogerM:

Why do you and some others keep saying that trade deficits occur because of comparative advantage? The trading of exports for imports occurs due to comparative advantage. Trade deficits can only occur 1.) if the population of a country as a whole wants to spend more than its income and 2.) if international borrowing is possible to allow domestic spending to exceed domestic income.

Yes, it is true that investment financed by foreign debt increases a country’s future wealth and income, if the rate of return exceeds the cost of foreign borrowing. (And that would be true for most rational investment.)

But what does all that have to do with the main thrust of RPM’s article. The main theme was summed up by his statement: “It is true that a net inflow of capital represents growing liabilities to foreigners. But is this necessarily bad? After all, THERE SHOULD BE A PRESUMPTION OF BENIGNITY TO EACH INDIVIDUAL TRANSACTION, SINCE IT IS VOLUNTARY.”

This part that I capitalized is the crux of RPM’s view of net foreign debt. Most market transactions have the quality that they are welfare increasing, but not all have this quality. Sometimes, the expected benefits of a transaction are not realized. And not all parties affected by every market transaction voluntarily choose to transact. This means that it is perfectly valid to question transactions (including those that lead to net foreign debt) as to whether the result is benign, good,or bad.

Hence, it is perfectly valid to question the level of U.S. net foreign debt resulting from capital inflows (trade deficits). I think most people would argue that many of the transactions (especially the investment ones) that contributed to the net foreign debt were good, and many of the transactions that have led to the present U.S. net foreign debt (especially some of the government budgetary decisions chosen to be financed by borrowing) were bad. This implies that a portion (not all, of course, but a portion) of the present foreign liability of the U.S. has resulted from transactions that were anything but benign to the present and future generation.

RogerM January 25, 2007 at 10:02 am

Alex: “This implies that a portion (not all, of course, but a portion) of the present foreign liability of the U.S. has resulted from transactions that were anything but benign to the present and future generation.”

I agree whole heartedly that some of the foreing debt is bad for the nation–the part that results from the federal deficit. But the problem is not the foreign indebtedness, it’s the federal deficit.

“Why do you and some others keep saying that trade deficits occur because of comparative advantage?”

Because comparative advantage causes trade, but it doesn’t guarantee balanced trade. Three things can cause the trade to be unbalanced:

1) Consumers in country A can’t produce a product, or can’t produce it as cheaply, as country B. Oil is a good example. Now if country B doesn’t want anything country A has to export, a trade deficit follows.

2) Savings in country A are too small for the projects that businessmen in A want to start, so businessmen borrow from the savings in country B.

3) Businessmen in country B see more opportunities to invest in country A than in their country B.

All of the above are covered under comparative advantage.

Reactionary January 25, 2007 at 10:21 am

RPM and RogerM,

I have rarely seen more disingenuous posts. Suffice it to say, you’ve had your clocks cleaned.

Alex MacMillan January 25, 2007 at 10:38 am

Yes, I think I’ll rest my case at this point. I really enjoy the discussions at this site, however.

RogerM January 25, 2007 at 10:58 am

Reactionary: “I have rarely seen more disingenuous posts.”

If you’ll point out where we were disingenuous, I’d like the opportunity to defend us.

Alex: “I really enjoy the discussions at this site, however.”

So do I. Your sharp observations really force me to think through the arguments carefully.

Reactionary January 25, 2007 at 11:40 am

RogerM,

You and Robert have ignored the point raised from the very beginning: the capital account surplus cannot progress to infinity. At some point, your grocer is going to stop accepting little pieces of paper from you in exchange for his groceries. That’s what a good part of the capital account surplus is: fiat currency and bank-created credit, NOT credit created from prior savings. This is why you and Robert keep erecting the straw man of trade deficits and comparative advantage, which nobody is arguing against.

Again, basic Mises: “Imports are in fact paid for by exports and not by money.” Theory of Money and Credit @ p. 286.

quasibill January 25, 2007 at 12:27 pm

RPM,

Per your last post, we are clearly talking past each other. I agree that you can’t just point to a trade deficit and say “bad”. But at the same time, you can’t point to our current deficit in context and say anything other than “really bad”. The context clearly matters, and a trade deficit tells you nothing more than what an accountant thinks of the exchanges that occur in the marketplace.

But if you look at the trade deficit in context, understand that it is persistent and increasing over a long period of time, and attempt to trace back the mechanism that is at the root, you CAN identify such long term, persistent, increasing trade deficits as the symptom of an economic illness.

Interesting example you use, but it doesn’t seem to be all that possible in the real world – who’s going to invest that much consistently over time in someone(s) who don’t produce anything capable of generating a profit? You’re making the same mistake RogerM continuously makes – investment is not some magical process that automatically results in wealth. Rather, it is at best an educated guess made by an expert in the field of predicting people’s wants, and at worse (in the presence of unrecognized fiat inflation) a bet placed on zero on the roulette wheel. Wealth results from investment ONLY after someone uses the investment to produce something someone wants at cost they’re willing to pay.

If you and RogerM continue to think that investment always produces wealth, I’d like to interest you in the Quasibill Wealth Creation (TM) fund. We invest your money – don’t ask how, ‘cuz it doesn’t matter how – and we all get wealthy!

“they’re holding dollar-denominated assets (US stocks and bonds) instead of cash”

What are U.S. bonds? A promise by the U.S. government to pay you a sum certain of U.S. $ at a certain date, backed by the full faith and credit of the U.S. government? Hmmm. Yes, I see the difference between that and that sum certain in $ on that date (or that sum certain minus a discount relative to inflation at this early date).

RogerM January 25, 2007 at 12:46 pm

Reactionary: “You and Robert have ignored the point raised from the very beginning: the capital account surplus cannot progress to infinity.”

You obviously don’t know the meanings of “disingenuous” or “straw man” so I’ll ignore those insults.

No one has ever claimed that the capital account surplus could progress to infinity.

“At some point, your grocer is going to stop accepting little pieces of paper from you in exchange for his groceries.”

I completely agree that hyperinflation will cause people to quit accepting dollars. When will the grocer stop accepting them? When hyperinflation exists, which doesn’t now exist and will not for the near future, at least.

“That’s what a good part of the capital account surplus is: fiat currency and bank-created credit, NOT credit created from prior savings.”

I’ve already agreed that fiat currency and bank-created credit aggrevate the situation. You say it’s a good part, but how much is that? 30%? 90% My guess is that it’s close to the rate of inflation, about 4%.

I’m not defending fiat money or bank-created credit. I’m as against them as you are. But I think they play a minor role in international trade.

In think this was Stephan’s point above when he wrote “However, as I pointed out in my article on the subject, to the extent that it is caused by budget deficit or monetary driven asset price bubbles, it is a bad thing, as it will then go to finance consumption and malinvestments.”

I agree completely. But those are small components of our international trade.

Stephan also discussed the issue of what would happen if the Fed stopped increasing the money supply, and concluded that the trade deficit would shrink. I agree. But it wouldn’t eliminate the trade deficit. Comparative advantage causes trade deficits, not monetary manipulation. Monetary manipulation can aggrevate the situation.

But if the Fed quit expanding the money supply, why would the trade deficit shrink? Simply because the American people have less money to spend. Plus, higher interest rates would encourage some increased savings, which would lessen the need for borrowing abroad. However, after prices had adjusted to the lower level of money, the trade deficit would resume normal levels to reflect comparative advantage.

RPM January 25, 2007 at 12:51 pm

Reactionary,

Can you find that Mises quote in the online version?

http://mises.org/books/Theory_Money_Credit/Contents.aspx

BTW I’m not accusing you of disingenuousness, but I can’t find the quote and I want to see the context.

Thanks.

Leonardo Baggiani January 25, 2007 at 1:08 pm

Amusing paper.

It surely shows a righteous “harmless current account deficit” point of view (when transactions are free, the outcome is widely desired by agents, so a sustainability concern has got no reasons to arise).

Mr Murphy, let me ask you: would your opinion be the same, in case a foreing Central Banker decided to massively buy your bonds and liabilities (creating your capital account surplus) thus forcing exchange rate upwards so to make you internationally non-competitive (creating your current account deficit)?

Mr Murphy, let me ask more: is actual USA situation somewhere inbetween these two extreems (free trade & foreing Centrale Bank bias) instead of purely “free”?

Mr Murphy, please, one more question: do not you think a “sudden stop” in foreing Central Bank policy would involve some serious problems thus arising a “sustainability concern”?

Respect
LB

Alex MacMillan January 25, 2007 at 1:58 pm

O.K., maybe just 1 more post.

I happen to have the following U.S. numbers handy for 2004: Net domestic investment=$893 billion; Household saving=$106 bill; Business saving=$478 bill.; Government saving= -$349 bill; current account balance = -$658 bill. New net foreign borrowing was therefore $658 billion.

Now, is there anyone who will claim that all the $658 was used to finance new domestic investment spending, and that none of it, for example, was used to finance the government spending-income gap of $349 billion, and that therefore none of the $658 billion increase in net foreign debt will lower incomes of future populations in spite of it increasing their debt service to foreigners?

RogerM January 25, 2007 at 2:27 pm

Alex: “Now, is there anyone who will claim that all the $658 was used to finance new domestic investment spending, and that none of it, for example, was used to finance the government spending-income gap of $349 billion, and that therefore none of the $658 billion increase in net foreign debt will lower incomes of future populations in spite of it increasing their debt service to foreigners?”

I think Murphy and I agreed that the federal deficit will lower future incomes. But that’s true whether we borrow from Americans or from foreigners.

Reactionary January 25, 2007 at 2:49 pm

RPM,

ch. 14, pt. 4. He also says it in what appears to be a precursor essay, “Stabilization of the Monetary Unit.”

Robert Blumen says the same thing in his review of The Dollar Crisis.

“Where trade occurs between nations, imports must ultimately be paid for with exports. This is a special case of the general principle that consumption must be funded by production.”

It also apparently appears in Mises’ essay “Etatism, Protectionism and the Demand for Lebensraum.”

“The ultimate goal of its foreign trade policy is economic self-sufficiency. The avowed tendency of this policy is, of course, only to reduce imports as far as possible; but as exports have no purpose but to pay for imports, they drop concomitantly.”

Again, basic stuff, and disingenuous of you not to acknowledge that fiat money has created a substantial capital account surplus unsupported by prior production and, therefore, creating numerous distortions and malinvestment. Nobody is arguing against free trade, but that is how you are casting your opponents’ positions.

olmedo January 25, 2007 at 3:20 pm

well,

am I the last one?

well, if you read your mises carefully youl notice taht the problem with money creation is not inflation or trade deficits, etc. by them selfs .

the real problem with money creation is a “CALCULATION PROBLEM”.

in a fiat money environment where money is created out of the blue and governments sponsor reckless credit creation there will come a time when citizens will not know what to do with their money(or will do the wrong thing with it as they are not able to “calculate”) , malinvestments will occur galore, and nominal savings will go out of wack with real savings.

this will eventually become big trouble for everybody that will manifiest itself not in trade deficits or inflation but in in a whole lot of unfinished projects that mean real “wealth destruction”.

if you add to this the government compulsion to intervene in times of troubles, well , then you have a “great depression”.

olmedo

Alex MacMillan January 25, 2007 at 5:42 pm

RogerM:

I agree with you (as anyone would) that a good portion of the present U.S. foreign liability has been the result of U.S. government spending in excess of its tax income. And, clearly you believe that this particular portion of the U.S. foreign liability has resulted from bad U.S. government decisions, not voluntary decisions that benefitted everyone concerned. But, that position violates RPM’s main premise that I’ve been harping about.

Stefan Karlsson January 25, 2007 at 6:18 pm

“If the Fed credibly promised never to print another dollar bill, there would be tons of net foreign investments in U.S. assets,i.e current account deficit would go way up”.

Oh really? And just what assets would they invest in? Bonds? Well, sure, bonds with nominal bond yields would rally big time. But there is no reason at all to expect real bond yields to decline. While there is good reason to think nominal yields would fall in the case of the destruction of the Fed (given the elimination of the inflation premium), there is no reason to assume real yields would fall. Indeed there is good reasons to expect them to rise, given, you know the law of demand, which I assume you (RPM) have heard of. The Fed creates money (as you may have heard) by buying government securities using the money they themselves created “out of thin air”. Lower demand (given the elimination of the Fed) will lower its price, or in other words raise their yields.

What about real assets (stocks, real estate etc.) then? Just why would foreign demand for that increase in the demand of the elimination of the Fed? As real assets do not lose real value in the case of inflation, but instead are more or less automatically increased in nominal terms, there is no reason at all to expect foreign net investment to increase. Indeed, as monetary inflation tend to disproportionately affect asset prices (aka prices of investment goods), there is every reason to think that the elimination of the institution which has artificially boosted asset prices, will lower their attractiveness.

RPM January 25, 2007 at 8:24 pm

Stefan:

Before trying to parse each step in your argument, I want to make sure I understand you. Right now there is a certain amount of foreign capital flowing into US assets. That is, foreigners decide to invest a certain amount in US assets, and Americans decide to invest a certain amount in foreign assets, and right now the foreigners want to put on net more into the US.

Now imagine Ron Paul somehow puts a magic spell on his peers and gets them to abolish the Fed and go back on a gold standard. You’re saying this would alter everyone’s decisions, and people would rush to move their capital out of this country?

Or we could try it the other way: If a Latin American country announces that it will start running the printing press at 100% per month, do investors flock to assets of that country?

Please realize that you can concede this point without thereby endorsing central banking. In fact, I would think this point would reinforce how bad it is: When you establish a central bank, you scare away investors who otherwise would’ve put real capital goods into your country.

But you’re saying I have this backwards?

Stefan Karlsson January 26, 2007 at 4:05 am

RPM, what you are missing is first of all the distinction between the 3 different forms of inflating, which I spelled out in my initial reply. The distinction between what one might call foreign exchange reserve accumulation, general price inflation and Austrian Business Cycle Theory(ABCT)-booms. Foreign exchange reserve accumulation is likely to lower the trade deficit/increase the trade surplus (depending on what the initial balance was), general price inflation is not likely to affect the trade deficit. There are however good reasons to expect a ABCT boom to expand the trade deficit.

When the Fed lowers interest rates, it will set into motion a investment boom. But this higher investment rate won’t imply lower consumption. Quite to the contrary. Rate cuts will raise stock and real estate prices which through the so-called wealth effect will -together with the lower interest rates- lower savings and increase consumption. But the only way that both investments and consumption can increase is through a increased trade deficit (or lower trade surplus).

While part of that trade deficit increasing effect will be cancelled out by the weaker currency implied by lower interest rates, it will only be part of it because 1) By lowering the current exchange rate more than the expected future exchange rate, it will make dollar denominated assets attractive despite lower yields 2) The inflationary boom by raising corporate profitability will make U.S. stocks more attractive 3) Asian central banks and oil exporting governments will then invest even more in dollar assets to ensure their currencies that don’t get so strong that their export companies get badly hurt.

These three reasons also spell out from why a monetary driven ABCT-cycle would attract the capital inflow needed to finance the trade deficit.

RM January 26, 2007 at 6:23 am

Stefan,

OK again, I want to make sure I understand your position. From your last response I take it that you agree with me, that if a Latin American country said it would start running the printing press like mad, that nobody in his right mind would invest there, and in fact everyone would try to relocate their assets out of that country. I.e. there would be a huge capital deficit / trade surplus in that country after the announcement.

So is it just a matter of degree? I.e. are you saying that if the Fed habitually added 50% to the money stock per year, and then it were abolished by Ron Paul, that _that_ would increase the trade deficit (as I’ve maintained all along)…

BUT, since right now the Fed isn’t so much as overall inflationary, but rather messes up relative sectors (stages in Mengerian terms), that this tendency of the Latin American country example is offset by the ABCT considerations?

Again, to sum up: I thought I made it pretty obvious in my last post that if you push it far enough, clearly an irresponsible central bank can cause world investors to steer clear of assets denominated in the currency that’s about to be devalued. You didn’t deny that, and instead made several distinctions among types of inflation.

So by that, I took it you agreed with my Latin American case.

Thus, the reason you deny my current claim–namely that if the Fed stopped printing new money, trade deficit would go up–is that you believe the Fed right now is being fairly responsible, and so isn’t scaring off investors in a hyperinflation-type scenario. In fact, you maintain it’s just the opposite, that perversely the Fed’s tinkerings have made the US a relatively attractive haven for foreign investors, more attractive than if the US were on a gold standard.

Is this right?

RogerM January 26, 2007 at 8:53 am

“Where trade occurs between nations, imports must ultimately be paid for with exports. This is a special case of the general principle that consumption must be funded by production.”

RPM won’t call you disingenuous, but I will, especially since you seem stuck on the term. You took that quote out of context, which is a clearly a dishonest move. Mises isn’t talking about trade deficits in that passage. He’s talking about exchange rates and irrational fears on the part of mercantilists. Here’s the lead sentence for the section:

“According to the current view, the maintenance of sound monetary conditions is only possible with a “credit balance of payments.”

To take that sentence out of context and try to make it Mises’s views on trade is simply dishonest. It suggests that Mises thought that trade in products and services should always balance.

Here’s a better passage:
“It is customary to list separately the monetary and the nonmonetary items of a country’s balance of payments. One calls the balance [p. 452] favorable if there is a surplus of the imports of money and bullion over the exports of money and bullion. One calls the balance unfavorable if the exports of money and bullion exceed the imports. This terminology stems from inveterate Mercantilist errors unfortunately still surviving in spite of the devastating criticism of the economists. The imports and exports of money and bullion are viewed as the unintentional outcome of the configuration of the nonmonetary items of the balance of payments. This opinion is utterly fallacious. An excess in the exports of money and bullion is not the product of an unhappy concatenation of circumstances that befalls a nation like an act of God. It is the result of the fact that the residents of the country concerned are intent upon reducing the amount of money held and upon buying goods instead. This is why the balance of payments of the gold-producing countries is as a rule “unfavorable”; this is why the balance of payments of a country substituting fiduciary media for a part of its money stock is “unfavorable” as long as this process goes on.” Human Action, http://mises.org/humanaction/chap17sec14.asp

It’s clear from this passage, and others, that Mises considered trade surpluses and trade deficits to be benign and that trade deficits could exist indefinately.

A little bit of history should make this perfectly clear: Japan and Germany have run trade surpluses with us for almost 50 years. Which of the three countries do you think is richer?

Alex: “But, that position violates RPM’s main premise that I’ve been harping about.”

Are you referring to his contention that we should view trade deficits as benign? RPM can defend himself, but I would argue that the Federal deficit is the problem, not the trade deficit. It’s entirely possible that without the Federal deficit, foreigners would purchase private bonds instead of government ones and the trade deficit might remain the same. It’s hard to tell, though.

RogerM January 26, 2007 at 9:06 am

Here’s another interesting passage from Mises:

“The maintenance of a sound currency has nothing to do with foreign trade. It is the old and fundamental error of all types of Mercantilism, that an unfavorable balance of trade drives money out of the country. But the balance of trade is one item only in the balance of payments. An excess of imports over exports is compensated or over-compensated by assets from other items. The balance of payments always balances. If both sides of the balance of payments equalize only by an export of gold, prices have to fall. The low prices increase exports and check imports. In countries where the currency is not purely metallic, the outflow of gold forces the Bank to restrict credit. Then the adjustment is effected by the inflow of foreign short-term loans attracted by the higher rate of interest. Thus, under both conditions, the equilibrium is re-established automatically.” Money Method and the Market Process http://mises.org/mmmp/mmmp9.asp

Clearly, in this passage Mises indicates that balancing the exchange of goods with money transfers is the normal working process. But that requires a trade deficit and capital surplus, something Mises doesn’t find objectionable.

Also, Mises writes “The theory of foreign trade as stated by Ricardo has proved in an irrefutable way that free trade only ensures the highest productivity of the economic efforts and that every kind of protectionism must necessarily result in a reduction of the output of capital and labor.” Mises was clearly a fan of Ricardo, who would never have insisted that trade in goods and services must balance.

olmedo January 26, 2007 at 9:08 am

“…if the Fed stopped printing new money, trade deficit would go up”

WRONG!!!, most likely interest rates will go up severely ( remember Paul Volker?), credit will collapse, and consumers and investors in todays “malinvestments” will go busted. Therefore, consumption will be much lower and with it, fixing the trade deficit.(no more Plasma tv´s any more!)

as assets prices will certainly go lower in the US , produced by the liquidation of malinvestments, export opportunities will arise however, this will not be that easy as it is not easy to transform a Walmart into an export oriented factory. It is much easier to hold consumption than to increase production.

i think this is a likely scenario (it already happened in the late 70s) if the possibility of a “run on the dollar” becomes evident to the fed . and I, personally believe, that this a likely scenario in the near future.

“”"if a Latin American country said it would start running the printing press like mad, that nobody in his right mind would invest there, and in fact everyone would try to relocate their assets out of that country. I.e. there would be a huge capital deficit / trade surplus in that country after the announcement.”"”"

YES and NO. Remember, people don’t invest in countries, people(ultimately) invest in assets, real assets. And assets are different and differently affected by inflation and Latin American countries do have real assets outside their crappy currencies.

I still remember going to Argentina as a tourist after the 2001 peso crisis, the only problem was booking flight, the country was flooded with tourist why, because buenos aires, one of the most wonderful cities in the world, went from being one of the most expensive cities to one of the cheapest. The tourist industry went from a bust , in the 90s, to an spectacular boom in 2001. The same happened in other competitive Argentinian industries like agriculture and wine making. However, the Argentinian consumer, who made a living in pesos, was “busted”..Poor guys!!!

Alex MacMillan January 26, 2007 at 9:28 am

RogerM:

In your Mises quote, “…imports must ultimately be paid for by exports…” the word “ultimately” does not imply that he said the trade balance must always be zero, with exports always equal to imports.

With regard to your question concerning what was RPM’s main premise of his article that I’ve been harping about, for the umpteenth time it is the RPM statement that I have capitalized in the following: “It is true that a net inflow of capital represents growing liabilities to foreigners. But is this necessarily bad? AFTER ALL, THERE SHOULD BE A PRESUMPTION OF BENIGNITY TO EACH INDIVIDUAL TRANSACTION, SINCE IT IS VOLUNTARY.” As I said in my last post to you, by your previous post, to which I was replying (about all that debt financed government spending partially contributing to these foreign liabilities), you must also agree that the capitalized remark is wrong. Right?

David White January 26, 2007 at 9:39 am

RogerM, your obviously don’t know what Mises is saying, as he’s talking about trade in a sound-money — i.e., gold standard — economy in which “The confrontation of the money equivalent of all incomings and outgoings of an individual or a group of individuals during any particular period of time is called the balance of payments. The credit side and the debit side are always equal. The balance is always in balance.”

Artificial political boundaries don’t change this fact — i.e., they don’t create “favorable” and “unfavorable” surpluses but are simply “the result of the fact that the residents of the country concerned are intent upon reducing the amount of money held and upon buying goods instead.” That’s why “the balance of payments always balances” and why it is definitely NOT the case that this “requires a trade deficit and capital surplus.” Sound money IS capital, and it has simply been traded for other capital goods as a result of resident individuals’ varying intentions.

Where a trade deficit DOES come into play is in a fiat-based economy, such that its work-free nature creates a deficit that can only be “repaid” through the expansion of that deficit, no matter that it be domestic (the “We owe it to ourselves” fallacy) or foreign.

In both cases, real deficits are created, the only difference in the present case being that as the world’s reserve currency, the “dollar” (i.e., the irredeemable Federal Reserve Note) all but requires foreign central banks to hold them in order to keep the value of their own currencies down so as to prop up exports.

The net of effect of these foreign bank holdings of the dollar via the purchase of US government bonds is to create vastly more debt than would otherwise have been created.

And bona fide Austrian that he is, this is precisely what Peter Schiff is arguing, why Robert Murphy is accordingly wrong, and why it is an outrage that such an anti-Austrian piece found its way into this forum. For the plain fact is that deficits DO matter and that our deficit has risen to the point that our economy teeters on the brink, only awaiting “diversification” out of the dollar, as it endlessly depreciates, for this Mother of All Ponzis to collapse.

Alex MacMillan January 26, 2007 at 10:36 am

Here’s how exports pay for trade deficits, even when there are continuing trade deficits and thus, year after year, an increasing U.S. foreign liability.

Suppose the foreign liability is $400. Suppose the annual debt service on that liability is 8%. The 8%x$400=$32 of U.S. funds that is received by foreigners in the year purchases $32 worth of U.S. exports. If the U.S. runs no more trade deficits, but simply maintains the foreign liability at $400 indefinitely, the present value of U.S. exports bought by foreigners with their $32 per year U.S. debt service receipts is $32/8%=$400.

The previous result is independent of whether the U.S. does run further deficits and increases foreign liabilities. For example, suppose there is a trade deficit (capital surplus) in a given year of $32. That is to say, the U.S. borrows from foreigners the $32 required to service their existing foreign debt. Does this mean the U.S. has escaped the pain of having to export some of its goods and services to service its $400 liability? Absolutely not. The $32 additional foreign debt must be serviced each year (say, also at 8%) by an additional 8%x$32=$2.56 of payments to foreigners, which are claims on U.S. exports. The present value of the additional $2.56 debt service to foreigners each year is $2.56/8%=$32. Every dollar of foreign debt acquired requires exports to service the debt. And, the present value of these exports is exactly equal to the amount of the debt.(Another way to look at is that in the absence of foregin debt, the payments to foreigners to service the debt, instead could have been used to purchase foreign imports.) However you wish to view it, each dollar of foreign debt is paid back in the form of exports (or fewer imports), either way a cost to the U.S.

quasibill January 26, 2007 at 10:54 am

“In fact, you maintain it’s just the opposite, that perversely the Fed’s tinkerings have made the US a relatively attractive haven for foreign investors, more attractive than if the US were on a gold standard.

Is this right?”

Once again, jumping in, but I’d say you’re ignoring the context again. Take this (I wish entirely hypothetical) example:

Country A uses fiat currency, and inflates its supply at just over 4% per annum over 5 years, say going from 5,000 billion dollars to 6,327 billion dollars in that time.

Country B, also on a fiat currency (a different one), increases its supply at some percentage, going from 5,000 billion to just north of 7,000 billion in the same time.

Where do you invest? Does that automatically make that country “better” than the gold standard?

Also, we can’t forget that knowledge of Austrian economics isn’t widespread among the investoriat. Just because we understand the nature of monetary inflation and its effects, doesn’t meant the dumbed down masses or even the financial sophisticates (who are most often Keynesians) do. Much of what makes the U.S. attractive right now is based on irrationality spurred by historical happenstance, coupled with ignorance of what is actually the state of the money stock. This sort of irrationality can reverse itself with a vengence.

David White January 26, 2007 at 11:26 am

This pretty much says it all, especially as it comes from the mouth of a former central banker:

Speaking specifically about the US trade position, Fell said: “The U.S. annual trade deficit, now running at a rate of more than three-quarters of a trillion annually, or 6.3 percent of GDP, is a huge concern. It’s not prudent for the U.S. to depend on foreign bond buyers to finance domestic consumption. Asian countries produce low-cost goods which are shipped to the United States, the U.S. ships dollars back to Asia, and then the Asians purchase U.S. treasuries. One could say this is a giant international Ponzi scheme. I don’t think this model is viable or sustainable. Asian central banks will not want to accumulate U.S. dollars at the current rate forever. There is no free lunch. Virtuous circles like this, where everyone appears a winner, always come to an unhappy ending.”

http://www.mineweb.net/mining_finance/599990.htm

RPM January 26, 2007 at 12:48 pm

quasibill: Country A uses fiat currency, and inflates its supply at just over 4% per annum over 5 years, say going from 5,000 billion dollars to 6,327 billion dollars in that time.

Country B, also on a fiat currency (a different one), increases its supply at some percentage, going from 5,000 billion to just north of 7,000 billion in the same time.

Where do you invest? Does that automatically make that country “better” than the gold standard?

To remind you of the context (which you think I am ignoring), I said that if the Fed stopped printing money, net foreign investment in the US would go up. So you should change your hypoethetical to:

Country A: 4% inflation per annum.

Country B: Pure gold standard.

Which country do I invest in? B. I think most others would say the same. Without knowing more, I’d guess B would have a capital surplus, i.e. a current account deficit.

But Stefan disagrees, I think.

RPM January 26, 2007 at 12:51 pm

David White,

If I can find a quote from a central banker who sees nothing wrong with the current system, will you say that cancels out your quote? Or are central bankers only experts when they agree with your view?

Also, I think there are plenty of “virtuous circles where everyone is a winner” in economics.

Once again, I am against central banking. It would be better if the US were on gold. And here’s where I differ from you guys, I say that improvement would manifest itself in more net inflow of capital, i.e. higher trade deficit.

David White January 26, 2007 at 1:15 pm

RPM,

“I think there are plenty of ‘virtuous circles where everyone is a winner” in economics.’ ”

I can think of one;i t’s called a sound-money, free-market economy. (But no, the central bankers loose big time, as they all go out of business.)

But as we no doubt agree on that, let me set the record straight by saying that Fell’s comments “say it all” not because he’s a former central banker. Rather, they say it all regardless of who said them and only gain force because of their source.

As for the issue as a whole, the inflow of capital would be good in a sound-money, free-market economy, as it would balance with the outflow in what one would expect would be burgeoning international trade. Under the circumstances, however — and there is no doubt in my mind that Mises would agree — the massive and ongoing deficit must ultimately unwind, spelling doom for the US economy.

In fact, I have a standing bet with Arthur Laffer in the amount of one constitutional dollar — i.e., “four hundred sixteen grains of standard silver”: http://landru.i-link-2.net/monques/coinageact.html — that the Federal Reserve Note won’t see its 100th birthday seven years from now.

RogerM January 26, 2007 at 1:48 pm

Alex: “AFTER ALL, THERE SHOULD BE A PRESUMPTION OF BENIGNITY TO EACH INDIVIDUAL TRANSACTION, SINCE IT IS VOLUNTARY.” …you must also agree that the capitalized remark is wrong. Right?”

For it to be wrong, you would have to show that invidual decisions to buy imports or invest in US assets are involuntary. I don’t see how that could be. Who’s forcing whom to do these things. I agree that the Federal deficit damages the future economy, and many foreigners and central banks are buying Federal bonds, but who’s putting a gun to their heads?

David: “Sound money IS capital, and it has simply been traded for other capital goods as a result of resident individuals’ varying intentions.”

I’ve already agreed above that fiat money aggrevates the situation, but it’s not the cause of trade deficits. It’s a small part of the problem.

“the “dollar” (i.e., the irredeemable Federal Reserve Note) all but requires foreign central banks to hold them in order to keep the value of their own currencies down so as to prop up exports.”

Not at all. Foreign banks have all kinds of options. They are not at the mercy of our inflation. They CHOOSE to buy up dollars from their people because of their flawed economics. They’re mercantilists! No one and nothing forces them to do anything.

“The net of effect of these foreign bank holdings of the dollar via the purchase of US government bonds is to create vastly more debt than would otherwise have been created.”

Not at all. Someone in the US has to demand the foreign money and supply the US bonds. The Federal debt was created by the US. Foreign purchasers have nothing to do with how much debt the Feds create.

Alex: “However you wish to view it, each dollar of foreign debt is paid back in the form of exports (or fewer imports), either way a cost to the U.S.”

You’re math examples are interesting, but they leave out so much and assume too much. The trade deficit could be paid for with new financial assets (stocks or bonds or direct investment), that is by creating new debt, from now to eternity without ever exporting a single good or service. But there’s a caveat: we could do that only if our economy grows faster than the growth of the debt. However, that shouldn’t be hard, for most businesses in the US finance their growth with huge amounts of debt, but the earnings from those investments easily service the debt with good profits left over.

David quoting central banker: “One could say this is a giant international Ponzi scheme. …Virtuous circles like this, where everyone appears a winner, always come to an unhappy ending.”

So a central banker is a mercantilist! Most of them are. Re-read what Mises wrote about the fallacies of mercantilism, or Adam Smith.

RPM: “I say that improvement would manifest itself in more net inflow of capital, i.e. higher trade deficit.”

Amen! A country with a pure gold standard would see its people getting richer than those in countries with fiat currencies and they would buy more imported goods. Also, businesses would grow faster without the the malinvestment caused by fiat currencies, so everyone in the world would want to invest in a gold-standard country, and that requires a trade deficit.

quasibill January 26, 2007 at 2:52 pm

RPM:

Well, then I’ll “up-context” you one more – what happens when Country B switches from its explosively inflationary monetary policy to the gold standard? What happens to the economy that was built in response to the easy money flow? To all the asset bubbles that grew in response to the easy liquidity? To all the debt used in its heavily leveraged hedge funds and private equity markets?

If the primary “growth” industry of a country is financial, what happens when the monetary spigots are shut off? What happens when the 1 in 4 new jobs generated in the last decade in finance suddenly come under deflationary pressures engendered by the shut off? What happens to the value of bubble assets when there isn’t more liquidity available to sustain the massive speculative industry that has grown up?

Sure, long run, after the short run collapse, the gold standard country is going to be more attractive to foreign investment. Short run, when people come to realize the reality of the bubble market, and turn from business models based on excess liquidity to models based on actually producing something that someone else wants, and especially if psychology overtakes economics (markets can remain irrational for longer than most people can stay in them) – things could be quite different in the short run. Even more different if this massive dislocation in the short term leads to massive state intervention based on popular outcries.

Suddenly, despite returning to a gold standard, Country B can look like worse place than Country A, if Country A’s assets haven’t been subject to the same bubble economics.

Finally, even if Country A’s assets ARE subject to an equivalent bubble, it is possible that after many years of outsourcing production in favor of financial bubble related industry in Country B, that Country A will survive the crash in much better shape than Country B – the infrastructure and capital base for actually producing things of value will be in better shape. While perhaps capital will see a higher return in Country B for a while due to this fact, the standard of living, etc., will likely be better in Country A for some time due to this fact.

One must never lose sight of the fact that investment doesn’t create wealth, entrepreneurial production does. One can invest his life’s savings in building a mock-up Klingon Battle Cruiser, but if it’s not coupled with entrepreneurial production, it won’t generate any wealth. Similarly, one can spend vast sums of money creating financial assets and markets to sell them in, but if it isn’t paired with entrepreneurial production, it won’t result in wealth. One of the problems with massive fiat inflation is that people tend to create major speculative markets that appear to generate wealth in response to the perceived surplus of savings. While running, these bubble markets will siphon capital from other, more actually valuable, markets, because the artificial returns are higher than anywhere else.

Does the term “artificially high return asset market” describe anything in the U.S. today? (note, to determine what a natural rate of return or P/E ratio on stocks is, you’d have to look at the market BEFORE the Fed came into being). Could not speculation based on such artificial returns play a major factor in the current balance of capital?

However, once the monetary spigot is turned off, these markets are revealed for the sham they are and collapse. Which is why it is wishful thinking to talk about them being turned off – there will never be sufficient political will to do so – hence Bernanke and his helicopters. What will happen is ever increasing liquidity to cover what’s already wrong, with increasing police state crackdowns on those who dare question or flout government policy by, say, engaging in trade with gold.

What could be a useful measure is somehow classifying what is “good” capital inflow right now versus purely speculative bubble stuff.

RPM January 26, 2007 at 3:03 pm

In fact, I have a standing bet with Arthur Laffer in the amount of one constitutional dollar — i.e., “four hundred sixteen grains of standard silver”: http://landru.i-link-2.net/monques/coinageact.html — that the Federal Reserve Note won’t see its 100th birthday seven years from now.

This is intriguing. What do you mean, though? You challenged him on the Internet, or would he actually know you and is aware of the bet?

And you’re saying the dollar won’t be used seven years from now?

BTW I doubt very much that prediction, but I applaud you for actually making concrete statements. As I said in the article, anybody can predict recession (or some other calamity) if not held to a timetable.

David White January 26, 2007 at 3:42 pm

RPM,

Yes, it’s a challenge based on an ongoing Internet exchange, and yes, I’m saying that the dollar will be history by then, though not necessarily that we will have returned to a gold standard.

More likely, I think, is that the crisis in the Middle East will be used by Bush or his successor (though I think that Bush, being increasingly desperate, will engineer it) will declare a national emergency in order to ram the North American Union down the American people’s throat — http://www.humanevents.com/article.php?id=14965 — doing so for two reasons: (1) to essentially naturalize the Mexican workforce in an attempt to stave off the collapse of our welfare system, and (2) to replace the collapsing dollar with the amero — http://www.humanevents.com/article.php?id=15017.

Sounds absurd, I know, but I frankly think there is bipartisan support for the NAU, as both parties know that no serious action will be taken by Congress to heed Bernanke’s warnings last week about the “severe” effects on the US economy “if government debt and deficits were actually to grow at the pace envisioned by the CBO’s scenario.” And however more absurd this may sound, it would not at all surprise me if Bush 39′s new best buddy Bill Clinton were appointed to head the NAU’s “governing body.” (You don’t think he could stand by and play second fiddle to the old ball and chain, do you?)

But in any case, I think we’re at the tipping point and that any number of events could send the US economy over the top.

After all, trade deficits are unsustainable. : )

RPM January 26, 2007 at 3:52 pm

Yes, it’s a challenge based on an ongoing Internet exchange…

I’m sorry to keep bothering you about this, but this really intrigues me. You’re saying the Arthur Laffer of Curve fame has sent emails back and forth with you, and agreed to this wager? When did this happen and how did you contact him? Through CNBC or something?

David White January 26, 2007 at 4:25 pm

Sorry, but that’s between him and me.

My plan, in any case, is to collect over lunch and the Waldorf’s Bull & Bear, then to land a speaking engagement at the next LRC conference. : )

RogerM January 26, 2007 at 5:00 pm

David: “My plan, in any case, is to collect over lunch and the Waldorf’s Bull & Bear, then to land a speaking engagement at the next LRC conference.”

I hope you lose, but like RPM, I applaud your nerve as well as the salesmanship required to get Mr. Laffer into such a bet.

David White January 26, 2007 at 5:22 pm

RogerM,

“I hope you lose…”

That’s the real irony in being a contrarian (as I think any true Austrian/libertarian must be). That is, if you’re standing on the deck of your beach house and see a tsunami coming, and yet can buy homeowners’ insurance on the cheap — and indeed as many policies as you like — then that’s the smart thing to do.

It’s not that you WANT the tsunami to hit; it’s that in seeing it coming (never mind that almost nobody else does), you place your bet (the Laffer one being but a side bet) and do whatever else is necessary to survive the catastrophe.

Maybe you won’t– i.e., maybe there’s no avoiding the tsunami, no matter how far inland you get — but you do what you can, determined to be guided not by wishful thinking but by critical thinking. And as the latter begins with questioning your assumption (something very few people do), you are fortunate to end up at forums like this one — even when you end up in disagreements like the one that has been going on in this thread.

Yes, I believe that Robert Murphy is wrong on trade deficits, and yes, I am outraged that LvMI chose to publish his article. But at least we’ve had the opportunity here to debate it, allowing visitors to decide for themselves who is right.

And time will tell in any case.

Stefan Karlsson January 26, 2007 at 5:32 pm

Well, RPM, yes, I am indeed arguing that current Fed policy have induced net capital inflow ( aka increased current account deficit). But net capital inflow isn’t necessarily a good thing ( another point which you seem to have missed). To make that point more obvious: in the end, aggregate economic statistics for countries are just the sum of the individual balances (and government balances) of the people living there. And so, what is true for individuals are also true for aggregates of individuals. Now imagine some liquor store salesman convincing some millionaire to use up all of his wealth to get really drunk -using the liquor store’s products of course- every single day during a full year or so. That would in trade accounting terms amount to a massive capital inflow to the soon impoverished ex-millionare. Would that be positive for the soon to be impoverished ex-millionare?

Sasha Radeta January 26, 2007 at 6:28 pm

Unfortunately, I don’t have time or patience to read a hundred and something responses to Dr. Murphy’s article. Instead, I will only reply to his original posting (response to Dr. Schiff). If I raise some points that were already addressed, please forgive me. The fact that the debate is still ongoing shows that objections were not effective enough (since Dr. Murphy is an open-minded intellectual who, unlike some contributors to this blog, seriously considers any objection that is raised against his arguments).

CURRENT ACCOUNT DEFICIT = CAPITAL ACCOUNT SURPLUS

Dr. Murphy states the following:

“…suppose that shovels are the only type of good in the world. In this (absurd yet instructive) scenario, a capital account surplus would mean that foreigners send more shovels into the United States than Americans send out; i.e., there would be a net immigration of shovels into the country in a given period of time.”

Following this hypothetical scenario, Dr. Murphy concludes that the US trade deficit of shovels is the flip-side of capital account surplus. However, by stating that the U.S. “purchased” shovels, he suggests that there was a monetary exchange involved in transfers of these shovels (in other words, shovels cannot be the only good in this example – there must exist some widely accepted commodity like gold). This means that the U.S. capital outflow (gold and shovels going to foreign countries) could theoretically be greater than the capital inflow (gold and shovels coming into the U.S.A.) if the price of shovels fell when the U.S. was selling them and went up when the U.S. purchased them from the world.

In the scenario with shovel-economy (for simplicity purposes, the planetary rate of interest is uniform and depreciation is miniscule), imagine that one U.S. shovel used to sell its shovels for 2$/unit (or an equivalent amount of gold), but the price went up when the U.S. imported shovels to the current level of 4$/unit. Also suppose that the U.S. purchased 50 E.U. shovels during a fiscal year, while the rest of the world purchased 20 U.S. shovels.
This means that the U.S. capital outflow amounts to: 200$ in. gold plus 80$ in current value of shipped U.S. shovels – for the total of negative $280.
At the same time, the U.S. capital inflow amounts to 40$ in gold (for sale of U.S. shovels) plus $200 in current value of imported E.U. shovels – for the total of $240.
Capital account balance of the U.S. amounts to a deficit of ($40).

Even without this hypothetical, it is not difficult to imagine a scenario in which a country may run both current account as well as capital account deficits. In 1990s FR Yugoslavia had a large current account deficit, largely due to the UN sanctions and unilateral transfers to Bosnian Serbs. At the same time, virtually no foreign investments took place, while people were fleeing the country, taking assets with them (capital outflow). Unlike Dr. Murphy’s (and Milton Friedman’s) scenario in which foreigners always bring us back those dollars that go out of our country (by purchasing American products like Fords or investing in our assets), no foreigners rushed to buy Yugos or to invest in a collapsed socialist economy.

ARE LIABILITIES ALWAYS BAD?

I agree with Dr. Murphy on this point – liabilities are not bad, as long as they are used for production. A country may even run small current account deficits, due to investments in new technologies, but the purpose of these investments is to produce revenues. If liabilities keep exceeding anyone’s liabilities year after year, something is probably wrong with that production. Note that I avoid using “trade deficits” as any useful parameter, simply because it cannot lead to any meaningful conclusion regarding a country’s economic performance. Trade balance sheet only records exchanges in goods, while any earnings on services (tourist sectors, etc.) do not count. Tourist paradises and tax havens are destined to have trade deficits, but no one would argue that they should do something about it by building heavy industries and forsaking its service sectors.

ARE THE TRADE DEFICITS UNSUSTAINABLE?

I also agree with Dr. Murphy on this point as well: trade deficits do not have to be unsustainable. Trade balance sheet only records exchanges of goods, while neglecting services and unilateral transfers. Current account deficits are not sustainable, because they are not synonymous with inflow of capital – but only with the outflow portion of capital account balance sheet. You cannot have a sustainable loss of financial assets over a long period of time.

USA: INVESTOR’S HAVEN?

Dr. Murphy looses his patience with Dr. Schiff and he states:

“Now we’ve finally hit the point where I’ve lost patience with Mr. Schiff. Does he really mean to say that these silly foreigners know less about their billions in investments than he does?”

Some lazy thinkers say that “cluster of entrepreneurial error” in Austrian business cycle also suffers from the same problem (we claim to know better than people who malinvest and loose their billions after an artificial boom goes into a bust). That is not a logically valid argument against Dr. Schiff. It is quite possible that the sense of relative security in the U.S. economy is based on boom during 1980s and 1990s, and GDP figures after 2000 that are mostly inaccurate and product of artificial credit creation.

olmedo January 26, 2007 at 9:11 pm

RPM:

“…if the Fed stopped printing new money, trade deficit would go up”

WRONG!!!, most likely interest rates will go up severely ( remember Paul Volker?), credit will collapse, and consumers and investors in todays “malinvestments” will go busted. Therefore, consumption will be much lower and with it, fixing the trade deficit.(no Plasma tv´s anymore!)

as assets prices will certainly go lower in the US , produced by the liquidation of malinvestments, exports and new investments opportunities opportunities will arise; however, this will not be that easy as it is not easy to transform a Walmart into an export oriented factory. It is much easier to hold consumption down than to increase production.

i think this is a likely scenario (it already happened in the late 70s) if the possibility of a “run on the dollar” becomes evident to the fed . I personally believe that this a scenario is possible (and necessary) for the near future the alternative is, reneging debts with inflation(hyper?) and, as a consequence, the collapse of the middle class as in argentina.

“”"if a Latin American country said it would start running the printing press like mad, that nobody in his right mind would invest there, and in fact everyone would try to relocate their assets out of that country. I.e. there would be a huge capital deficit / trade surplus in that country after the announcement.”"”"

YES and NO. Remember, people don’t invest in countries, people(ultimately) invest in assets, real assets. And assets are different and differently affected by inflation and Latin American countries do have real assets outside their crappy currencies.

I still remember going to Argentina as a tourist after the 2001 peso crisis, the only problem was booking flight, the country was flooded with tourist why, because buenos aires, one of the most wonderful cities in the world, went from being one of the most expensive cities to one of the cheapest. The tourist industry went from a depresion , in the 90s, to an spectacular boom in 2001. The same happened in other competitive Argentinian industries like agriculture and wine making.Thus, foreign capital went to those. On the other side, the Argentinian consumer, who made a living in pesos, was “busted”..Poor guys!!!

Sam January 26, 2007 at 11:14 pm

Aw shucks, olmedo, I think you may have answered a question I was going to ask: would the fact that foreigners getting U.S. dollars as payment be incentive against hyperinflation of the U.S. dollar? Your reply seemed to say that international trade isn’t enough to necessarily make a difference as hyperinflation is going to be a great kick in the guts to poor and middle class who couldn’t/didn’t invest in quality assets.

So a new question would be: if foreigners said ‘we want you to pay us in Euros not your crappy U.S. dollars, would U.S. importers comply knowing that wealth redistribution caused by hyperinflation is affecting U.S. folks?

And are liabilities bad? I’d say definitely yes. A liability is something that is causing you a net loss. An asset conversly is something which gives a net profit. A computer which I’d use to play nothing but games on would a outright liability. But if I used a computer in my self-employment to make a living then it more than pays for itself and would be an asset. I’d say Robert Kiyosaki’s (Rich Dad Poor Dad) definition of assets and liabilities are great eye-opener toward basic financial competency.

olmedo January 27, 2007 at 8:24 am

Sam:

in an honest money evironment:

-savings are good.
-liabilities are good only insofar you make assets more productive then creating real wealth.
- honesty and hard work are basic.

in a “inflationary ” environment like the one we are living now:

- savings become the surest way of loosing your money.

- liabilities are good (or great)in the sense that you “short” a constantly depreciating money (you pay present money with a depreciated future money).

-and expertise in second guessing the central banker becomes the most important job skill anybody could have.

In a few words , it is pure PERVERSITY because you have no other choice than go with the flow no matter how wrong you see everything turning around you.

Thats is the reason you see now massive indebtedness all over, little savings , reckless expending that could become frantic as inflation accelerates (is the only real way for the small consumer to protect himself against inflation).

and yes , money can be made and by the ton if you know what to do and are willing and “capable” of leveraging your self to the “tilt”. That is precisely what the hedge fund industry does with leverage that, unlike the old days when Rothbard complained of fractional reserves of 30% and so but, acts with massive leverage of 15 to 1 and 30 to 1 in some cases. and this is big and growing.(Goldman, 9.5 billions in net profits this year)

however , don’t try this at home, this is only for the rich an knowledgeable with access to easy and cheap (free) credit . and unlike entrepreneurs in an “honest money” environment, these guys dont make money by creating wealth they create money by transferring it from those that don’t count with the same skills. Remember, as Mises said, “money is not neutral” that is what is bad about inflation.

olmedo

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