the majority of there reserves are in SHORT -term bonds so they will let these mature and continue to DRASTICALLY CUT NEW PURCHASES

not sure what the lag time is between reporting of updated reserve totals but they will go down not from selling but from old bonds maturing and new bonds not being bought

I appreciate your attempt to reinvent accounting, but there is a good reason why liabilities are also recorded as assets (that is the only way to evaluate true potential of some firm, because liabilities can be utilized for production… of course, the ownership structure of assets is also very important and that is why we have ratios that measure liquidity and leverage).

At any rate, however you view liabilities that does not change that you were incorrect in stating that liabilities must produce a net loss.

Also, it does not change the fact that any discussion about “are liabilities bad” (balance sheet issue) is completely misguiding and useless in the contest of current account balance (income statement issue). Likewise, current account deficits (loss of capital in financial assets) cannot be equated with capital account surplus – because these deficits only represent the outflow portion of that account, without determining the value of capital inflow.

PS
Sam, only the fulfillment of liabilities can be viewed as an expense (that is when you no longer can use these assets). As long as you hold liabilities, there is no ground to claim that they will cause you a net loss, or net profit. They are just assets for all we know.

Who is confusing expenses with liabilities? I apologize if I was confusing.

You stated this:
“And are liabilities bad? I’d say definitely yes. A liability is something that is causing you a net loss.”

In other words, you viewed all liabilities as something that automatically reduces your profit (expense and nothing else). That is an incorrect view, since liabilities (obligations from past transactions) can be utilized for creation of new assets and they can produce profits (not just loss as you claimed).

You seem to have a strange definition of assets. As you know from the basic accounting equation, Assets = liabilities + owners equity. What any firm does with those liabilities will be reflected in its performance and on income statement. We all know that.

—-

That is not the real issue here.

The real problem in our topic is not the question: “are liabilities bad”. What Dr. Murphy seemingly suggested is that a net loss does not have to be bad. I tried to explain why current account deficit (outflow of financial assets, which is one part of our total capital) does not necessarily translate into capital expense surplus (just as net loss of a firm does not suggest increase in its total capital). I illustrated my position with some concrete examples.

Having a liability-free production makes as much “sense” as consuming only what you produce. If you are poor on capital, but you have a great idea for some new products, would it make any sense to stay poor and not to borrow someone else’s capital in order to create your fortune?

Liabilities per se are not the real issue here. The problem here is that some people get so hyped when they discover how useless and absurd any analysis based solely on trade balance calculation is – and they jump to a conclusion that current account balance does not matter. In other words, they are saying that constant net loss (not only liabilities) can be a great thing for an economy.

Imagine a firm that keeps loosing money, year after year, because it invests more in new technologies than it actually gains in assets. How would we rate its performance? There is a physical limit on how long a firm can endure a net loss, and at any rate, it is not a desired outcome (although it maybe an inevitable outcome of heavy investment in something that should produce an account surplus).

Some people also don’t understand that this net loss in current account does not necessarily translate into a capital account surplus, because any capital acquisition (inflow) is balanced by an outflow of capital that was used in such purchases. In other words, you will have a capital account surplus only when the value of your acquired capital exceeds the value of capital that you lost – and current account deficits (net loss) cannot magically yield this outcome.

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

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.

“…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!!!

CURRENT ACCOUNT DEFICIT = CAPITAL ACCOUNT SURPLUS

Dr. Murphy states the following:

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:

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.

“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.

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.

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’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?

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. : )

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.

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.

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.