No, a Trade Deficit Does Not Mean More Debt

Here’s an e-mail that I just sent to AEI’s James Pethokoukis:

Mr. Pethokoukis:

I admire your work greatly. Even on those rare occasions when I disagree, I learn something from your writings. So it’s with more than a little trepidation that I send this e-mail.

You get much correct in your recent post “A brief, simple explanation why the Trump theory on trade deficits is wrong.” Indeed, I agree with your central point. And I agree too with much of the passage that you favorably quote from JP Morgan’s Mike Feroli. But your post would have been stronger – much stronger – had you objected to Mr. Feroli’s claim that “every dollar by which US purchases from abroad exceed sales to abroad is matched by a dollar that is borrowed by someone in the U.S. from someone overseas, who has chosen to invest that dollar in the U.S.”

I realize that it’s conventional to describe a trade deficit as increased indebtedness. Yet this convention is both mistaken and dangerous.

This convention is mistaken because, contrary to Mr. Feroli’s claim, in practice only some – and in principle possibly none – of a trade deficit becomes debt. For example, BMW’s use of dollars to build its factory in Greer, South Carolina, caused the U.S. trade deficit to rise, but this greenfield equity investment by a foreign firm in the U.S. did not cause a corresponding rise in American indebtedness. Only that portion of the U.S. trade deficit that foreigners actually lend to Americans becomes American debt.

This convention is dangerous because, by conveying the mistaken impression that we Americans are more financially indebted to foreigners than we really are, it further fuels efforts to obstruct trade. If more Americans understood that the U.S. trade deficit can rise without making Americans more indebted to foreigners, then President Trump, Peter Navarro, and other protectionists would have a more difficult time scaring Americans into accepting restraints on their freedom to trade.

Protectionists already have disproportionately large – I’m tempted to say unfair! – P.R. advantages in the public debate over trade policy. We free traders should not allow protectionists the unjustified additional advantage of speaking and writing of changes in the U.S. trade deficit as if these changes are synonymous with changes in Americans’ indebtedness.

Sincerely,
Donald J. Boudreaux

Here’s my introduction to this post on Facebook:

Joe builds a better mousetrap. He uses his profits to buy a house for cash, for U.S. dollars, in Buffalo, NY. If Joe lives in Buffalo – or in Butte, or in Maui, or anywhere in the U.S. – no one supposes that Joe’s purchase of his new house in Buffalo causes any American(s) to go further into debt. But if Joe lives in Toronto, then people will say that Americans are now more indebted by the amount of the purchase price of the house. The convention of describing changes in a country’s trade deficit as being synonymous with changes in the indebtedness of that country’s citizens is very common – and very wrong.

Republished from Café Hayek.