Thursday, September 15, 2011

U.S. Trade With Rest of World is Always Balanced

The Bureau of Economic Analysis released detailed data today on U.S. international transactions for the second quarter of 2011. 

For the first six months of the year, the U.S. had total cash outflows of $1.9 trillion that represent: a) $1.575 trillion in spending by American consumers and companies on imported goods and services, and income payments (dividends and interest) by U.S. companies and governments to foreigners who own U.S. assets (stocks, bonds, bank deposits), and b) a $335 billion cash (or capital) outflow from Americans buying foreign assets (stocks bonds, bank deposits, direct investments in foreign firms), see chart above.

Over the same period, there was a total cash inflow to the U.S. of $1.9 trillion from: a) $1.4 trillion for U.S. exports and income payments that were made to Americans who own foreign assets, and b) a $510 billion cash (or capital) inflow from foreigners buying U.S. assets. 

For America’ "current account" (the first category outlined above for goods, services and income payments) there was a $175 billion "current account deficit" for the first half of the year.  For investment/capital flows, the U.S. had a $175 billion "capital account surplus" (or “capital inflow” or “investment surplus”), which exactly offset the $175 billion current account deficit.   In other words, our overall trade with the rest of the world remained in balance for the first half of the year, after accounting for all cash inflows (+$1.9 trillion) and cash outflows -$1.9 trillion), and there really is no overall "trade deficit."

While most of the media attention focuses on America's "trade deficit" for goods and services, a more complete analysis always reveals offsetting surpluses for other international transactions that result in a "balance" of our total payments (cash outflows) and receipts (cash inflows) with the rest of the world.   Because international transactions are calculated using double-entry bookkeeping accounting, international accounts HAVE TO BALANCE on net, and the Balance of Payments has to equal ZERO, just like a corporate "balance sheet" has to balance such that Total Assets (TA) = Debt (D) + Equity (E); and TA - (D + E) = ZERO.

Bottom Line: Even though it's not "newsworthy" and won't be covered by the media, America's international transactions were once again balanced from January-June this year, just like every quarter and every year, and the "balance of payments" was once again ZERO. (What a relief!)

8 Comments:

At 9/15/2011 1:33 PM, Blogger Benjamin said...

Yes, but does this mean we owe more and more money to foreigners, and they have greater and greater claims on our output?

They give us goods, and we give them IOUs. Interest on those IOUs allows them to put a claim on our output. Akin to a tax.

Yes, some foreigners may chose to convert their debt to equity in the USA, and I heartily encourage that. In that case, we have our cake and eat it too, so to speak.

As the world's reserve currency, we can also just print money and pay off bills. I like that solution immensely, btw, especially at the current time when demand is weak and inflation dead.

Still, I wonder if households, business, governments or nations can borrow their way to prosperity.

 
At 9/15/2011 2:00 PM, Blogger morganovich said...

"Still, I wonder if households, business, governments or nations can borrow their way to prosperity"

business surely can as can individuals.

if you bowwow money, use it to build a factory, then make money producing goods, then of course you can borrow your way to prosperity. it's an integral part of business formation and makes the savings of others useful.

the case for governments is less clear. sure, they COULD borrow their way to prosperity, but, in practice, they don't.

if you borrow, you need to put the money to productive use to cover paying it back with interest. this is not how governments think.

they borrow money, use it to buy votes, then kick the can down the road hoping someone else will get left holding the bag.

there is nothing wrong with borrowing money. many fortunes have been made that way, but it only works if you put it to productive use. borrowing money for unproductive purposes leads to mountains of debt and nothing to show for them.

 
At 9/15/2011 2:28 PM, Blogger Sean said...

morganovich,

there is nothing wrong with borrowing money. many fortunes have been made that way, but it only works if you put it to productive use.
Borrowing money to invest has bigger upsides but also bigger downsides than simply investing present assets. Risk exposure of an institution is generally worth measuring.

 
At 9/15/2011 2:49 PM, Blogger morganovich said...

"Borrowing money to invest has bigger upsides but also bigger downsides than simply investing present assets. Risk exposure of an institution is generally worth measuring."

i think it's a bit more complex than that.

if you incorporate, then borrow for a business, it's much less risky for you that using your own money.

but sure, if you have cash to invest, it's lower cost and risk to you to use it if you are on the hook for the loan, but it also let's you do things you otherwise could not.

few people have the capital to start a business sitting around in cash.

it's also a cost of capital issue.

i just took out a $417 mortgage on my house (for which i paid cash). i have an interest rate in the 2's locked in for 30 years.

take that cash, and buy 30 year bonds levered at 3:1, and voila, over 7% annualized return even after cost of capital with significant front loaded tax advantages.

that's borrowing creating prosperity for me. it's very low risk if held to maturity.

it's just a cost of capital vs expected ROIC issue.

borrowing does not make it more dangerous, it just affects the return spread.

it's also found money.

if i left that money stagnant in the house, it earns no more than the house earns now.

this way, i get more return than i would have had.

after tax advantages, $35k a year isn't so bad for return on cash i didn't even have.

 
At 9/15/2011 3:21 PM, Blogger Sean said...

morganovich,

Good points, but I think the key there is passing on the risk to others.

You've got:
1. Bonds that have a higher rate of return than your cost of capital, and which presumably have acceptable risk.
2. Your borrowing is subsidized by the government (relative to other activities

Borrowing to invest is generally risky because the debt can't be avoided but the return on investment isn't guaranteed. Yes, there are ways around that through incorporation or taking advantage of government subsidies such as the mortgage interest tax exemption. But finding that good investment and getting another actor to sign up on the risk (whether government or private investors) is usually the hard part, wouldn't you say?

 
At 9/15/2011 4:30 PM, Blogger Benjamin said...

Morgan-

You actually make a lot of good points. Borrowing is vital to, say, capital investment.

But how about borrowing to finance consumption--much of our trade deficit has that feel about it.

 
At 9/15/2011 5:20 PM, Blogger marmico said...

take that cash, and buy 30 year bonds levered at 3:1

Who is lending to you in the 2s and with what collateral for the leverage?

You do realize that interest deduction for home equity debt is less than $417 [thousand] of principal.

 
At 9/18/2011 10:50 PM, Blogger Cameron Murray said...

Accounts must always balance - credit this, debit that.

But the important point is what under which account the debits and credits are going.

Trade in goods and services can be 'unbalanced' in isolation, but gets balanced because when there is a deficit, the gap is made up by increasing debts to foreign entities, or selling assets.

As Benjamin says, the capital account balances current account deficits by accouting for increased foreign liabilities.

So the question is, can these liabilities be maintained indefinitely, or will the day come when they must be repaid.

 

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