In a previous post, I objected to Mark Perry’s own post about the U.S. trade deficit. The title of Perry’s post captures his point: “US has a net inflow of goods and a net inflow of capital. Team Trump wants the opposite?”
I pointed out that if a populist in Japan tried to impose schemes to keep Japanese savings “working for us here in Japan,” then surely Mark Perry and other free traders would object–and rightly so. But if a free trader would assure someone in Japan not to worry about their capital account deficit, then how can free traders assure Americans that a capital account surplus is self-evidently a good thing?
(For an analogy, if a free trader looked at kids swapping lunches at school, it would work to say, “Ah, you value what you got more than what you gave up. So this makes you better off.” But it wouldn’t work to say, “Billy got a cookie instead of spinach. And Team Trump wants the opposite?”)
Now Don Boudreaux defends Mark Perry over at CafeHayek. Don writes:
Mark’s point (in summary) is that if the voluntary economic decisions of Americans and foreigners result in a U.S. current-account (“trade”) deficit – which is to say, a U.S. capital-account surplus of the very same amount – Americans should not be upset. The reason is that a U.S. capital-account surplus means that the American economy is a net recipient, not only of imports, but also of capital. And being a net recipient of capital is not only not necessarily a bad thing for Americans, but is likely a good thing.
No, I have to cry foul. If *that* is what Perry had written, then you wouldn’t have heard a peep out of me. But as I took pains to emphasize in my original critique, that’s *not* what Perry wrote. There’s nothing in there about “…is likely a good thing.” No, go read Perry’s post again if you don’t believe me. Clearly, his argument is that it’s self-evidently a good thing when your country has (a) more goods and (b) more capital flowing into it than out of it. And that’s clearly not a good argument, unless you think all of the countries on the other side of the equation are in trouble and that their people should fret about the trade statistics.
But beyond me thinking that Don is being too generous to Perry in his summary of his post, Don and I actually have a substantive disagreement. Here’s Don:
I believe that Bob’s objection misses the mark. A capital-account deficit (that is, a current-account surplus) is indeed more likely than is a capital-account surplus to signal a problem with the national economy. If Japan consistently runs capital-account deficits, this fact is likely evidence that good investment opportunities in Japan are too few – and made too few by poor government policies that make the investment climate in Japan less attractive than it would be absent these poor policies.
I understand what he’s getting at, but I simply disagree. One last thing before I dive into my example. After reading Don push back against me, someone in the comments wrote: “Once again, you are confused. The current account deficit is not the same as the trade deficit.” To which Don gave an exasperated response, wondering how this guy could possibly think Don doesn’t understand this distinction.
OK, so now I’m going to give an example of what I think these critics have in mind. As I always say on these types of posts, on policy matters Don and I are in perfect agreement. But I think I see how Don sometimes is misunderstanding his critics, and they are talking past each other. So please keep that in mind when you try to understand, “What is the purpose of Bob giving us this scenario?”
A certain nation loves Adam Smith’s quote that what is prudence for a household can’t be folly for a great kingdom, and its people heed the wisdom of Deuteronomy 15:6 that says, “For the LORD your God will bless you as he has promised, and you will lend to many nations but will borrow from none. You will rule over many nations but none will rule over you.”
So in practice what happens is that the people of this nation save a large fraction of their income every year. After a while they have exhausted the great investment opportunities in their country and on the margin, it is more attractive to invest abroad. Thus, in a typical year, the people in this nation acquire more foreign assets on net than foreigners acquire of financial assets that are claims on the nation. That is to say, our hypothetical nation consistently runs large current account surpluses / capital account deficits, both in absolute money terms and as a share of their GDP. (The people always save a large fraction of their income, even as it grows rapidly because of their frugality.)
Now at first, you might think that this means our people end up sending more goods out of the nation than they import each year. But that’s wrong. What actually happens is that their nation runs a trade deficit while they nonetheless experience a current account surplus.
For example, in the most recent year the foreigners held (I’m converting to US dollars for our convenience) $10 trillion worth of foreign assets, in the form of bonds, stock, real estate, etc. That generated an income over the course of the year of $500 billion to our hypothetical people, because on average they earned 5% on their foreign assets.
In contrast, foreigners around the world only owned $4 trillion worth of assets in our country, in the form of corporate stock. (Remember, these people are wary of outside control, so they don’t issue bonds or sell real estate to foreigners. They do allow foreigners to buy shares of corporate stock in IPOs though.) These foreigners earn an average of 2.5% on their stock, meaning they earned an annual income of $100 billion.
Now in addition to these facts, I’ll report to you that our people sold $600 billion worth of goods to foreigners, while our people imported $750 billion worth of goods. In other words, there was a trade deficit of $150 billion. More goods flowed into the country as imports, than flowed out of the country as exports.
However, notwithstanding the trade deficit, there was still a current account surplus of $250 billion. That means our people had a capital account deficit of $250 billion. That is to say, our people invested (on net) $250 billion more in additional foreign assets than vice versa.
If you want to step back and see what’s happening: Our hypothetical people earned $500 billion in (gross) investment income from their foreign assets, and they earned an additional $600 billion from exporting goods. Then with that $1,100 billion in total income in foreign currencies, they paid $100 billion that they owed as corporate dividends to the foreign holders of their stocks, they bought $750 billion worth of imported goods, and with the remaining $250 billion they acquired additional foreign assets.
Now I’m not saying that this is necessarily the goal; certainly you wouldn’t want governments passing measures to try to achieve the above outcome. (For one thing, it’s impossible for every nation to be a net lender to every other nation.) But I think my example is the kind of thing that many of Don’s critics have in mind, and why they think free traders who keep telling Americans that a capital account surplus is a good thing, are missing something.