Wednesday, December 7, 2016

Does the Balance of Payments Really Balance?

TT emails:
Perhaps you can explain something that I hear over and over again, but seems to be totally incorrect.  People write that "the trade deficit doesn't matter because it is offset by a capital surplus".  I believe this is patently false and misleading and shows a deep misunderstanding of basic accounting concepts as well as cross border flows.  Consider the following example:

I, an American, own $1 million dollars in US Treasury Bonds.  I sell those bonds, and use the proceeds to buy disposable goods from a Chinese company.

Putting aside costs and so for simplicity, the Chinese company now has $1 million.  They take those dollars and buy the Treasury Bonds that I previously owned.

Under your analysis, there is no issue because our Trade Deficit of $1 million is offset by a capital surplus of $1 million.  Of course those two numbers "offset" in arithmetic terms but they are hardly equivalent.  At the end of the day the US population has transferred $1 million of wealth to the Chinese population.

As Pat Buchanan pointed out, we have a cumulative $4 trillion deficit with China, so in effect we have transferred $4 trillion of wealth to them. 
Also, the story about Trump being "clueless" about the Softbank deal is equally flawed.  Softbank is going to bring NEW money into the USA from wherever they have it now.  This will create jobs and perhaps exports (really irrelevant).  It will NOT in any way increase the trade deficit.

If I am wrong I would appreciate a detailed response to my points. You have a big following and its important that your readers are getting accurate stories. Thank you. 
 My response:
You are doing what Trump is doing looking at just one side of the equation at any given point.

You write: "At the end of the day the US population has transferred $1 million of wealth to the Chinese population."

But this occurred only because we received $1 million in goods which was the only way the Chinese gained the funds to buy the bonds.

You write: "Softbank is going to bring NEW money into the USA from wherever they have it now.  This will create jobs and perhaps exports (really irrelevant).  It will NOT in any way increase the trade deficit."

US dollars, aside from being held as physical cash, must be used in the US, either on investments or consumption goods. If Softbank acquired the funds because of earlier goods sold overseas (Or otherwise, if it was a US investment overseas it is really a US deal), it means that much was spent on trade and because the money received from that trade is used to invest in the US as opposed to purchasing goods or service it creates a trade deficit.

Note: This also is a response to the comment left by at the post, Clueless Trump Just Hails a $50 Billion Increase in the Trade Deficit. writes:

You assume that the $50 billion dollars that is to be invested within the USA would otherwise have been used to purchase $50 billion dollars of US goods and services, which is an absolutely ridiculous assumption to make. Your Trump Derangement Syndrome at work again.
It is not absurd, it requires complex thinking to understand but it is an identity that by definition is correct.

Let me try to make it clear one more time via Investopedia:
A capital account shows the net change in physical or financial asset ownership for a nation and, together with the current account, constitutes a nation's balance of payments. The capital account includes foreign direct investment (FDI), portfolio and other investments, plus changes in the reserve account...
A country’s balance of trade is part of its balance of payments. For example, the balance of payments in the United States is composed of three subaccounts: the current account, the capital account and the financial account. Each has its own types of inflows and outflows.
Greg Mankiw in Principles of Macroeconomics explains it this way:
An important but subtle fact of accounting states that, for an economy as a whole, net capital outflow (NCO) must always equalt net exports (NX): 
This equation holds because every transaction that affects one side of the equation affects the other side by exactly the same amount, This equation is an identity--an equation that must hold becasue of the way the variables in the equation are defined and measured.
Not everyone is going to understand this but it is a fact.

That said, its usefulness is another thing. And we have Murray Rothbard to point this out:



  1. .
    The author misses the point again.
    ... " But this occurred only because we received $1 million in goods ..."
    A Million in trash is what was received, now that million in trash sits
    in a land dump.
    Disposable goods, plastic trinkets, target stores are full of them, with a one year
    if not one month if not one week lifespan / entertainment span.
    The manufacturing JOBS are gone as is the MONEY.

    If you have no job, you have no income, and you can no longer afford the
    trinkets and garbage. It is a death spiral. The money leaves.

    The CONSUMPTION Economy turns into the GOVERNMENT HANDOUT economy.



    FOOD STAMPS ( government handouts ).
    Ridiculous theory is slapped in the face by reality.

    1. "A Million in trash is what was received"

      Trash according to who? You? Value is subjective and thus your assessment that everything we got was trash is demonstrably false.

      "The manufacturing JOBS are gone"

      They are gone mostly because of increased productivity, not International Trade:

      "as is the MONEY."

      Money is not wealth. It is a means to acquire wealth.

      "Ridiculous theory is slapped in the face by reality."

      Indeed. Did it hurt?

    2. Excellent to see you understand subjective value and comparative advantage ...


    3. .

      The Jobs left the US. NOT due to productivity but due to CHEAP labor
      and few and far less government environmental and other regulation indeed
      Lower Cost of production - and in many cases ( steel & aluminum examples ) SUBSIDY / ARTIFICIALLY LOW Costs.

      CHINA was one of the beneficiarys, Once the JOBS left, the MONEY left too.

      CHINA accumulated billions and NOW China with that very money is BUYING the US Corporations ( and UK and others ) and in effect transferring more intellectual property to China.

      The Proof

      Reality A Slap in the face to the silly theories.
      . Everyone benefits with free trade - what a joke..
      Ask A Greek what he thinks of the free trade with A German. Real Free .

      Balance of Trade in Greece averaged -2352.77 EUR Million from 2001 until 2016

      Balance of Trade in Germany reached an all time high of 25899.00 EUR Million in March of 2016 and a record low of -535.91 EUR Million in April of 1991.


    4. True, she says, she works 11-hour days, six days a week, and shares a dormitory with nine other women and gets to see her husband only once a week. She had to leave her three-year-old daughter back home in Sichuan. And there is only a communal bathroom, and if they want hot water they must fetch it from another floor. But at least she has a job, she says. And others have it worse.

      Xiao is one of thousands of workers in Chinese factories making some of this year’s must-have Christmas toys.

      An investigation with the US-based NGO China Labor Watch reveals that toys including Barbie, Thomas the Tank Engine and Hot Wheels were made by staff earning as little as 86p an hour.

      Overtime can run to nearly three times the legal limit. In some factories – including one producing Happy Meal toys for McDonald’s from the new DreamWorks movie Trolls – that means some are on 12-hour shifts and have to work with hazardous chemicals.

      The grim truth of Chinese factories producing the west’s Christmas toys
      Undercover investigation by China Labor Watch exposes low wages, hazardous chemicals and overtime beyond legal limits


    Friedman spent much of his "Lecture Time" on providing examples of this idea. Wanniski as well. The "Tariff Problem" over and over: I'm still looking for the video from Friedman asking, "If we buy a million dollars of Goods and Services from Japan, what are they going to do with that million dollars? Put it under a mattress? Then, we get these goods and services for the price of paper and ink. No, they will take that million and buy other goods and services that they need."

    The problem then appears to be resolution of imbalances in time. A Tariff - or a Smoot-Hawley Bill - interrupts the resolution of imbalances which would occur. A Market is suddenly shut off and agreements must be re-negotiated, often with other Partners. Until then, things pile up on docks with no buyers.

    Markets Clear.

    That phrase, however, has a positive interpretation as well, since the acquisition of the Materials from Trade raises everyone's ability to live well. "They lived on a dirt floor but it was a Socialist dirt floor..." is small comfort to those who aspire to live a better life.


  3. Voluntary trade is complete and self-contained at the moment it is executed. It really doesn't matter what the other party does with what they received from me. I could care less. They could burn the dollars for all I care. I'm made better off from what I received from them, or we would not have made the transaction.

  4. RW, what I don't get is WHY this "requires complex thinking to understand". THIS (complexity) seems to be the reason there is so much confusion. It seems like it should be easy to understand. After all, it is just goods & services flowing back and forth. The math is grade school level. If this is simply:

    Savings - Investment = Exports - Imports

    then where is the confusion? Obviously, it occurs when foreigners trade away their US dollars. I suspect part of the confusion is simply that others will say "foreigners will simply sell their dollars". So why is it that these discussions never cover that case? I don't get it. This seems to be the elephant in the room that economists can't see but average people do.

    Also, I understand why politicians get this wrong. They ALWAYS cater to the masses. But why can't economists gang up on them? There seems to be no concerted joint effort to do anything about it. Don't 99% of eonomists agree with you on this?

  5. Mr. Wenzel,

    What's your take on this in relation to the national debt? If China (or anyone else) gains money from selling us goods, then buys US debt with the profits, who gains? Obviously if we lose out, the problem is with our debt and not with the trade deficit. If they buy debt instead of invest in companies or goods, does this cause us to lose out or gain for some reason?