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US economy and the trade deficit
Gerard Jackson
Many economists will tell you that there is nothing wrong with trade deficits. After all, they will say, trade is mutually beneficial, so those foreigners who sell to Americans are benefitting as much as those Americans who buy the products. This is a superficial view that completely misses the point.
It’s not a question of deficits in themselves: it’s a question of what one might bad deficits as against good deficits. To some economists, there is no such thing. Once again I beg to differ. They are wrong about this just as so many of them are wrong about economic growth and consumer spending.
I intend to stress that bad deficits are like the spots measles produce. They are symptoms, not causes. Now the bad deficit occurs when the central bank lets loose with the money supply, usually through our old enemy credit expansion. Now I have already discussed elsewhere how this monetary policy triggers booms and inflates asset values. But there is also the effect on the trade balance.
Inflating spending leads to an increased demand for imports. Eventually the demand grows, unless monetary policy is tightened, until it reaches the point where the central bank sees it as another warning signal that monetary policy needs to be tightened.
In 2000 America’s trade deficit rocketed by 40 per cent compared with 1999. This was one very big jump indeed, and one that may very well have given Greenspan a well deserved case of heartburn. But why should that be? Wasn’t he also called the “Great Economic Helmsman”? It was no wonder I began to believe that Greenspan thought an iceberg was a famous Swedish actress.
This brings us to January 2001 to June 2006. During this period M1 rose by about 25 per cent. (Australia did even worse with M1 rising by about 35 per cent). Where in heavens did economists think all money was going? And commentators wonder why the trade deficit deteriorated. In plain English, the deficit jumped because America was, and still is, exporting inflation. I realise that probably most economists would argue that a monetary expansion of this size and occurring over 51/2 years is really nothing to worry about. Such sanguinity is based on the untenable belief that money is neutral. This blinds them to the damaging micro-economic consequences of an expansive monetary policy.
America has therefore been exchanging billions of ‘surplus’ dollars for foreign goods and services. That some of the money returns, even as repatriated profits from overseas subsidiaries, does not alter the process or its consequences one bit. The argument of repatriated profits overlooks the possibility that an overvalued dollar may even have created these subsidiaries. And that brings me to another important and greatly overlooked point.
America’s monetary expansion has misdirected production in certain countries by increasing the demand for their exports. This has misdirected investment from production for the domestic market to the American market. In short, they have over-invested in export industries to satisfy America’s inflated demand for imports. When American demand slumps these foreign export industries will be particularly hard hit given the number of years they have spent expanding output to serve American consumers.
Larry Lindsey, president Bush’s former economic adviser, was another who told Americans not to worry about the deficit. According to him a trade deficit simply means investment exceeds savings. Pure Keynesian claptrap. Investment in excess of savings is another term for inflation, a situation created by credit inflation. (This credit expansion has now resurrected the hoary myth of surplus capital. Never mind that this myth had been discredited 200 years ago by James Stuart Mill in an exchange with Jeremy Bentham).
It is true that for nearly 100 years America ran a current account deficit that added enormously to the country’s capital structure. But this was because these investments were paid out of genuine savings, not funny money. British investors lent Americans huge sums (real savings, not phony bank deposits) who then used them to buy vast quantities of British-made capital goods.
These investments eventually paid for themselves. Put another way, British investors directed capital goods from British use to American use. Being on a gold standard ensured that the savings were real and not simply book-keeping entries. Today, however, ‘excess investment’, really means credit expansion and that means inflation — irrespective of how general prices behave. The following was said by Bernie Fraser when he was Governor of the RBA (1989-96):
If demand runs ahead of capacity, it will spill over into imports and widen the current account deficit (CAD). This is what happened in 1989-90 when the deficit reached 6 per cent of GDP. On this occasion the CAD is not expected to increase to the very high levels reached during the lat 1980s. (Reserve Bank Annual Report, 1994).
Keynesians just don’t put the cart in front of the horse, they damn well shoot the poor creature. No matter what Keynes claimed, credit expansion cannot turn “stone into bread”.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 31 July 2006