IWith the U.S. trade deficit at record levels, the Wall Street Journal’s Greg Ip warns readers that the imbalance could “lead to a crisis in which the dollar falls much more sharply, driving up interest rates and squeezing the economy.” Ip’s colleague, Jeff Opdyke, picks up on the weak-dollar theme, a phenomenon that to his way of thinking is “being spurred along by fears of large budget and trade deficits.”
Each writer is caught up in a contradiction that suggests a weak dollar is the cause and cure for trade deficits. In seemingly believing both sides of the contradiction, Ip and Opdyke reveal an impressive misunderstanding of why people trade in the first place, of what stimulates trade, and of what is actually the cause of trade deficits. If history is any kind of indicator, currency movements (up or down) have had virtually no impact on the balance of trade — either way.
The answer for why people trade is very simple. They do so to make a profit. In the words of 19th century economist Jean-Baptiste Say, the merchant prefers to speculate in the goods that will “bear the greatest value when they arrive at the place of destination.” This reality explains why rich nations often run trade deficits.
Consider Gillette. It’s top-of-the-line M3Power Razor sells for $13.99 in the U.S. In England, the same product sells for $17.78. The 27 percent markup is without a doubt a positive for Gillette and its shareholders, but for those who calculate trade imbalances, the $3.79 gained overseas would add to the U.S. trade deficit.
On the other hand, it’s well known that U.S. pharmaceutical firms sell drugs in Canada and other foreign countries at prices that are fixed below what those same drugs cost here. Without getting into whether this is right or wrong, drug-company profits would be healthier if the drug companies could command a market price for their goods overseas. Since they cannot, the price controls forced on them by foreign countries actually improve our trade deficit by virtue of the fact that the Pfizers of the world export one value and receive a lesser value in return.
Someone who disagrees with the above reasoning might argue that since prices are sticky; that lowering the value of the dollar versus other currencies would in fact make goods produced in the U.S. even cheaper overseas and expand the profit margins on goods like the Gillette razor. This might make intuitive sense until it is remembered that the value of the imported inputs and commodities that comprise finished U.S. goods must necessarily rise to reflect the weaker dollar. Or, as H.C. Wainwright’s David Ranson has pointed out, “inflation steals the benefits of devaluation.” Furthermore, what if “competing” countries match our devaluations?
David Malpass, NRO Financial writer and chief economist at Bear Stearns, has regularly pointed out that unstable currencies, be they weak or strong, overwhelm any short-term advantages/disadvantages thought to be gained while currencies are unstable, and in the end serve to restrain trade altogether. Figures on U.S. exports compiled by the Census Bureau confirm his point.
In 1960, total U.S. exports were roughly $26 billion. By 1969, the yearly number had risen nearly 90 percent to $49 billion in total exports to the world. The Nixon administration took us off of the gold standard in August 1971 in order to weaken the dollar and stimulate exports. In dollar terms, the administration succeeded famously. Total exports post-devaluation rose 300 percent between 1970 and 1979, from $56 billion to $224 billion.
But as the late Robert Bartley noted in The Seven Fat Years, “Money is a veil,” and changes in its value will not change the real price of anything. Just as redefining the inch shorter will not make a person taller, redefining the dollar down in the 1970s did not make the exchange of goods any more common or more valuable.
In fact, the devaluation restrained it. In the stable-dollar 1960s, U.S. exports rose nearly 90 percent in real terms. In the 1970s, a decade characterized by a weaker, less-stable dollar, total exports rose 300 percent in nominal terms, but as the dollar fell nearly 250 percent versus the yen, and over 1,000 percent versus gold, the real value of trade during the decade fell substantially.
The trade deficit? It rose throughout the 1970s, from $1 billion in 1971 to $24 billion in 1979, the exact opposite direction of what those advocating devaluation as a “cure” would predict today. The dollar rose throughout the 1980s, and the trade deficit’s rise continued from $19 billion in 1980 to $93 billion in 1989. Between 1996 and 2001 (years of impressive dollar strength) the trade deficit rose 250 percent, but it has also risen to record levels during the last 2 years of relative dollar weakness. Currency values have very little to do with trade deficits.
All of which leads to the question of why we have trade deficits, and what we can do about them? The answer is that absent passing ghastly anti-growth measures that succeed in scaring away investors, not much.
Amidst all of the hysteria between Ip and Opdyke about evil trade deficits, the Journal’s Money & Investing section ran an article on foreign capital inflows titled, “Why Foreigners ‘Buy America.’” Arthur Laffer has regularly pointed out that the trade deficit is the flip side of the capital surplus, and he’s right. Almost unrelated to currency movements, foreign capital inflows into the U.S. have skyrocketed since 1995, from roughly $80 billion to over $600 billion in 2004. Unsurprisingly, the trade deficit has risen alongside those inflows. Foreign investors were net buyers of $81 billion worth of U.S. securities in November alone.
Until foreign investors find a better, safer place than the U.S. to park capital, we will run large trade deficits. That the U.S. is a magnet for world capital is a compliment. Currency manipulations are proven failures in moving the balance of trade up or down. We could reduce the trade deficit, but it would require higher taxes, higher tariffs, and higher unemployment for us to do so.
The trade deficit is a misunderstood figure. It is in fact unambiguously positive for the economy of the United States.
–John Tamny is a writer in Washington, D.C. He can be contacted at jtamny@yahoo.com.