Arnold Williams (notebuyer) wrote,
Arnold Williams

Trade Deficit: Good or Bad?

We have two sides to consider:

The one presented by Cafe Hayek

The trade deficit is nothing to worry about.

First, a growing trade deficit for the United States can cause the dollar’s exchange rate to fall, but it doesn’t necessarily do so. Let’s assume for the moment, however, that the price of the dollar in foreign currencies does indeed fall. Good or bad for Americans?

In a myopic sense, it’s bad, for each dollar now buys fewer imports. But in a fuller, longer-run sense it is neither bad nor good in and of itself. The price of the dollar, like all prices, reflects underlying realities. The ‘right’ exchange rate is the one that reflects as accurately as possible these underlying realities.

If foreigners find themselves holding too many dollars relative to their demand for dollar-denominated goods, services, and assets, the dollar’s exchange rate will fall. The lower exchange rate will decrease American imports and increase American exports, reducing America’s current-account deficit.

I view such an occurrence as being neither good nor bad. Of course, it might reflect deeper problems with the American economy (such as an inflationary monetary policy), but it might also reflect nothing more awful than changing tastes and circumstances abroad. Either way, there’s nothing suspect about the open trade that led foreigners to hold so many dollars that the dollar’s exchange rate falls.

And the one presented by BrooksNews

To say that a country can have too much savings is to argue that it can accumulate too much capital. But a country can never have enough capital.

Griswold’s argument fare’s no better. Investment exceeds savings when the central bank runs a loose monetary policy. This was debated in much detail during the bullion debate in England more than 200 years ago.

Because of the Napoleonic War the British government suspended gold payments in 1797, giving the Bank of England carte blanche to inflate the note issue. In 1800 Walter Boyd sent his Letter to Pitt which was then published the following year. Boyd’s thesis was that the suspension had inflated the money supply which had raised the price of bullion and generated balance-of-payments problems.

This generated a barrage of criticism. But Boyd’s point was well made by the fact that between 1797 and 1800 the Bank of England had nearly doubled its note issue. Moreover, these notes were then used by the country banks to multiply their bank deposits.

Boyd, Lord King, David Ricardo and their supporters became known as bullionists. (Despite the rewriting of history Henry Thornton was not in the bullionist camp nor did he believe in the dangerous fallacy of neutral money). Ultimately their thesis that it was inflation that drove the pound down and created a gold drain became generally accepted.

Henry Thornton’s insight was that by forcing the rate of interest below its market rate the money supply is expanded. This artificially stimulates the “needs of business” and results in savings exceeding investment, what Bentham called “forced frugality”. (For more on forced savings see Friedrich von Hayek’s Prices and Production, Pub. Augustus M. Kelley 1967).

Lord King demolished the concept of neutral money with the insight that new money enters the economy at different points bestowing its benefits on those who first receive it. It would have been one short step from King’s insight to see that monetary expansion creates malinvestments, disproportionalities as the classical economists called them.

King’s analysis was directly along the lines of Richard Cantillon’s observations which were laid out in his Essay on the Nature of Commerce in General (Transaction Publishers, New Brunswick [U.S.A.] and London [U.K] 2001, first published c1730).

From this all too brief overview of the bullion debate we can draw the conclusion that America’s current account problems lie with the Fed’s loose monetary policy. In defence of that policy it can be argued that from America’s foundation to 1870 investment exceeded domestic saving even though the country was on a gold standard for most of that period.

In general, I'm less impressed with people who argue from economic history: they tend to elide understanding. So I'll choose the first.

How about you?

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