The Strange Notion That U.S. Trade Is Balanced

by: Howard Richman

In the April 5 Forbes Magazine (The Gold Standard and the Strange Notion of "Balanced Trade"), commentator Nathan Lewis argues that despite the fact that U.S. trade deficits were running at a $631 billion per year rate in January, despite the fact that the U.S. trade deficit with China alone was $282 billion per year in 2011, that there is no such thing as imbalanced trade.

He is correct that imbalanced trade is balanced by flows of savings in the opposite direction. He writes:

In actuality, all trade is balanced. Let's say you are a businessman or investor. You want to trade something for something else. For example, you want to trade goods, services or assets for money (sell something), or you want to trade money for goods, services or assets (buy something).

Probably you are doing both of these at the same time, so in effect you are trading the things you sell for the things you buy, with the money acting as an intermediary. You probably end the process with roughly the same amount of money that you started. Money itself is an asset, of course.

OK Mr. Businessman, have these trades ever been "imbalanced"? Did you ever give goods and services and get nothing in return? At least not on purpose, right?

If that did occasionally happen, what you have in effect is an obligation for your counterparty to deliver something in the future, which is a type of asset, so even then you receive something in return. This would show up on the Current Assets portion of your balance sheet as an Accounts Receivable or something of that sort.

When trade is out-of-balance, the country exporting more than it imports does get something in return. The 16th century mercantilists got gold in return. The modern mercantilists get iou's, usually interest-paying bonds, in return. In effect, the modern mercantilists are lending money to their victims.

But Lewis shows his complete and utter lack of understanding of modern mercantilism when he sees nothing wrong with this bargain. If he wants to educate himself on this topic, he could read the refereed-journal article that I wrote with my son and father on the subject (The Scaled Tariff: A Mechanism for Combating Mercantilism and Producing Balanced Trade).

Some economists think that these mercantilist loans benefit the victims. However, any benefit is just short term. At the same time that they give the victims more consumption, they take away investment opportunities in the victims' trading sectors. The result is that the victims get to live beyond their means for a short time, but they lose their industries.

As the late University of Chicago economic historian Jacob Viner (16th Century mercantilism) and Chinese economist Heng-Fu Zou (modern mercantilism) made clear in their seminal writings, mercantilists sacrifice consumption in the present in order to get even more consumption and power in the future. We pointed out in our journal article that their policies produce the exact reciprocal effect in their victims: increased consumption in the present followed by decreased consumption and power in the future.

In the 1500s, the mercantilist countries of Europe used imbalanced trade to steal Spain's industries and power. By the end of the century, Spain had gone from the dominant power in the world to an economic has-been.

Since 1996, the mercantilist countries of Asia have been using imbalanced trade to steal U.S. industries and power. The decline in U.S. industrial investment has been quite significant. As shown in the graph below, as U.S. net exports (exports minus imports) have declined, U.S. net investment in manufacturing (fixed investment minus depreciation) has also declined:

The Dean of Peking University's School of International Studies writes that China's continuing economic victory over the United States proves the benefits of dictatorship over democracy. He attributes America's economic failures to the polarized domestic politics within the United States. But China's success and America's failure only prove that mercantilism is a successful strategy when its victims don't insist upon balanced trade.

Lewis is correct about one thing: the gold standard is not the solution to mercantilism. Even if the U.S. were to adopt the gold standard, other countries could still practice modern mercantilism by lending back to us the gold they receive from us through trade. The ideal solution would be for the victims to impose the WTO-legal scaled tariff that we recommend.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.