Recently, one of the directors of the Washington Post, Warren Buffett, said that the U.S. was on its way to becoming a “sharecropper’s society.” The statement characterizes the Washington Post’s latest economic theory on international trade. In a recent editorial entitled “A Sharecropper’s Society?” the Post bemoans America’s sacrifice of future standards of living for current consumption by selling out to foreigners:
Every year Americans sell or mortgage a slice of their productive assets to foreigners with the result that income from those assets must flow abroad in the future.
Does the Post’s economic position make any sense? Let’s investigate.
When Americans sell a piece of their productive assets, they receive an agreed upon payment in return. This is a voluntary transaction at the “market” price, which means the buyer and seller are both satisfied with the price. This price should reflect the present value of all expected future cash flows of the productive asset that is sold. The seller also has the cash resources that can be used to purchase foreign productive assets, build U.S.-based productive assets, or simply be saved.
If a loan funded a buyer’s purchase, the loan also “creates” an equivalent deposit. The transaction means that the loan itself creates the funds that buy the productive assets. The funds do not come from some mythical “pool of savings,” as described in the “loanable funds” rhetoric freely tossed around by the media and others who should know better. It’s a zero-sum game, in the sense that loan/deposit expansion does not create any net financial assets. However, the economic activity created by the purchase of goods and services and related loan creation increases output and income so that the economy grows accordingly.
More, the Post’s idea that income “flows” abroad is not what happens. Let’s go back to the April 10, 1984, edition of the Wall Street Journal. Leif Olsen, the chairman of Citibank’s economic policy committee, made the following important distinction in a letter to the editors:
If you hear “import,” what immediately comes to mind? You’ll probably say “cars.” Now, if you hear “capital flow,” what do you think? Money coming in, right? Wrong. Money doesn’t come in from abroad like cars. It’s already here.
In other words, money doesn’t flow offshore. Rather, domestic claims change hands. Many economic commentators miss the fact that when the U.S. went off the gold standard in 1971, there was no longer any guarantee behind the U.S. dollar — it became a fiat currency. As such, there was no gold being moved around in the basement of the Federal Reserve Bank of New York to settle liabilities to foreigners. Foreign holdings of U.S. assets, namely Treasury bills, must be redeemed some day but can only be redeemed for U.S. dollars and spent or “saved” as U.S.-dollar financial assets. Foreigners can trade U.S. government liabilities, but in the end, the “buck” stops here.
To some extent, we are “mortgaging” our future, but the transaction whereby we consume their resources now and they consume our resources later is a game that is stacked against foreigners since our policies are the ones that set future domestic prices, export taxes, and restrictions. In other words, we can decide to reduce the future purchasing power of foreigners via the multitude of legal policy options at hand.
Equal trade, whereby we consume foreign labor (a.k.a., creating jobs abroad) by buying their goods in exchange for U.S. financial assets that allow foreigners to buy our goods in the future, can provide the flexibility for each trading partner to time purchases of goods and services. For example, Japan has been accumulating net U.S. financial assets for decades and not net spending. For all practical purposes the Japanese are satisfied with the U.S. consuming their physical resources in exchange for their accumulation of U.S. financial assets indefinitely. And, as previously noted, we have perfectly legal policy options to unilaterally minimize the value of their holdings of U.S. financial assets should we so decide.
What are the Post’s editors attempting to do? Are they implying that selling now is bad and that not selling is good? As I mentioned, the total transaction — buying now with I.O.U.’s given to sellers for their future buying — works entirely to our advantage. What is important is that the transaction takes place: Domestic credit creates the loans and deposits (there is no such thing as “imported capital”), we get the goods and services, foreign investors are paid for their output with the newly created deposits, and non-resident savings are created for possible future spending.
The U.S. population benefits, without a sharecropper among us.
– Thomas E. Nugent is executive vice president and chief investment officer of PlanMember Advisors, Inc. and principal of Victoria Capital Management, Inc.