Thursday, December 21, 2006

Embrace Trade Deficit, Embrace Capital Inflow

From today's WSJ, an editorial by Bear Stearns's chief economist

"For decades, the U.S. trade deficit has been a political and journalistic lightning rod, inspiring countless predictions of America's imminent economic collapse. The reality is different.

Our imports grow with our economy and population, while our exports grow with foreign economies, especially those of industrialized countries. Though widely criticized as an imbalance, the trade deficit and related capital inflow reflect U.S. growth, not weakness -- they link the younger, faster-growing U.S. with aging, slower-growing economies abroad.

With all the negativism about the U.S. economy, it's easy to forget its attractiveness. Foreigners are as eager to invest in the U.S. as we are to buy goods and services from them -- it's a two-way street. The trade deficit is the mechanism allowing consumption and investment in the U.S. to grow faster than in Europe and Japan."

Bottom Lines:

1) As the graph above clearly shows, there really is NO trade "imbalance" when you account for trade flows of merchandise (current account) and trade flows of capital (capital account). The $800 billion trade deficit on our current account is exactly offset by an $800 billion capital account surplus. In other words, the Balance of Payments is always ZERO, -$800b (current account) + $800b (capital account) = 0. Trade accounts are based on double-entry accounting, so there can never be a deficit without an offsetting surplus, and there can be no trade "imbalance."

2) The "trade deficit" on our current account (merchandise) gets all of the attention, and the "trade surplus" on the capital account (investments) gets little attention. A Google news search for the phrases "current account deficit" and "capital account surplus" shows that "current account deficit" appears 4X as frequently as "capital account surplus," even though they are "two sides of the same coin."

3) We get the best of both worlds: a) we get to shop globally for the best and cheapest products the world has to offer and b) we attract investment capital from all over the planet that helps finance the expansion of our companies, and helps finance your student loan, mortgage or car loan.

Embrace the trade deficit, and embrace the capital inflow that results from the trade deficit.

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