Record Trade Deficits

Reading an individual's balance of payments is very revealing. By comparing the income and the expenses of an individual, we can determine the position he or she occupies in economic life. The income ledger discloses not only the height of income but also its various sources. There may be labor income from services we render to our fellowmen, or interest income which flows from the value difference in the passage of time, or entrepreneurial profit which springs from the correct anticipation of changes, or transfer payments by way of charity or force of law. The expenditure ledger, on the other hand, reveals a great deal about our spending habits. It discloses the amount of money we presently spend on consumption or set aside for the future either as investments or as cash holdings. Using double-entry bookkeeping, the income side and the outgoing side are always in balance. There can be no surplus or deficit in an individual's balance of payments.

A country's balance of payments is equally revealing, although reading and interpreting it may be more demanding. It records all of a country's economic transactions with the rest of the world during a particular period of time. It is typically divided into three accounts: current, capital, and gold and money. While there can be no surplus or deficit in the overall balance of payments, the accounts can show imbalances. The "current account" registers imports and exports of goods and services; the "capital account" covers movements of investments; and the "gold and money account" reveals the transactions of all kinds of money.

When economists speak of "balance of trade" they refer to a subgroup of the current account, to a country's imports and exports of merchandise. It covers movable goods such as foodstuffs, automobiles and apparel, but does not include payments for services and tourism. When a country exports more than it imports and thus earns a surplus of money and bullion, it is said to have a favorable balance of trade; when imports exceed exports, the balance is called unfavorable. This terminology obviously stems from age-old Mercantilistic reasoning which prevailed in Europe after the decline of Feudalism. It built on the notions of irreconcilable conflict among the commercial interests of nations and on the importance of bullion. In order to export more goods and import more money, it led governments to impose countless restrictions on trade and to pursue policies of establishing colonies and favoring certain industries. In basic philosophy and policy, it was akin to modern socialism.

The United States presently is suffering massive current- account deficits which create much uncertainty and generate great fear in international relations. Until 1997 the deficit never exceeded $150 billion annually, or 2% of Gross Domestic Product(GDP). Since then it has soared to unprecedented levels. In 1999 it reached a record high of $331 billion, or 3.7% of GDP. In 2000, it is estimated to exceed $425 billion, or more than 4% of GDP. To finance such deficits in the trade of goods and services, Americans need to seek foreign loans or investments of $425 billion a year or $1.2 billion every day. Many economists are questioning the capacity of the world economy to finance such U.S. deficits. They are likening them to a financial sword of Damocles suspended over the world's financial structure by a single hair.

Many observers point to the Asian financial crisis of 1997- 1998 as the primary cause of the soaring deficits. When the credit bubble burst in Thailand and financial markets tumbled throughout the region, they point out, Asian purchasing power declined precipitously, which visibly curtailed the Asian demand for American products. But the American demand for Asian products rose significantly with the collapse of Asian currencies. Moreover, they contend, the crisis led to a flight of liquid capital into quality, that is, into U.S. dollars and dollar investments which boosted the exchange value of the dollar. The soaring dollar in turn supported the American demand for foreign goods while it discouraged foreign buying of American goods. The result was a mounting trade deficit.

To look upon the Asian crisis as the cause célèbre for the growing current account deficits is to charge a few poor Asian countries for the economic ailments of the world's largest and richest power. The Gross National Product (GNP)of Thailand where the crisis began is less than 2% of that of the American economy ($165 billion vs U.S. $9 trillion), and its per-capita income is l/12th of American income ($2,700 vs $32,000). Just 13.9% of its small volume of imports come from the United States and 19.6% of its exports go to the U.S. The GNP of South Korea, which was painfully affected by the crisis, amounts to some 5% of the American ($485 billion vs. $9 billion) and per-capita income to just 1/3 ($10,550 vs. $32,000). To point to Thailand, South Korea, or their poor neighbors for causing American ailments is unrealistic and unworthy of American observers. But worst of all, it mistakes symptoms for causes and charges the victims with causing the plight. In order to fathom the American deficit phenomenon, we must search for American causes and analyze American policies. They affect the world, for the U.S. dollar is the standard currency of the world.

Any analysis of contemporary financial problems must begin with the stellar position of the U.S. dollar in world finance and trade. It must acknowledge that the U.S. dollar has assumed the very position that gold and silver used to occupy throughout the ages. The dollar gradually assumed this position after World War II and attained it officially in 1971 when President Nixon defaulted in U.S. gold payments. Other governments willingly accepted the fiat dollar because, in American footsteps, they, too, could default on their gold payment obligations.

During the age of the gold standard the balance of trade of the gold-producing countries was as a rule "unfavorable." The United States experienced deficits during the 1850s when large quantities of gold were mined in California; the same happened in South Africa which became the primary gold-producing country during the 1890s. The rising stock of gold raised goods prices, which induced the residents of the gold-producing countries to buy more goods abroad. The balances of trade turned "unfavorable."

Since the 1960s the United States has become the primary "money-mining" country of the world. The Federal Reserve "mines" the U.S. dollar. Every central bank and every foreign commercial bank, wherever it is permitted, holds U.S. dollars to make international payments or merely to keep a reserve. Just as the gold-producing countries experienced trade deficits, the United States is recording deficits. It does so for the same reason the gold-producing countries did in the past: the rising stock of money raises goods prices, which induces Americans to buy more abroad. But while the gold-producing countries had to spend much labor and capital in order to acquire the gold and buy more goods abroad, the Federal Reserve System merely prints the fiat money at minuscule expense.

Although the U.S. dollar has taken the place of gold in international commerce and finance, it is not gold. It is paper money decreed legal tender. It is fiat which maintains its eminent position in the world because of lack of a better alternative. In contrast, gold has been the money of man since the dawn of civilization. Throughout the ages it emerged again and again because man needed a dependable medium of exchange. Gold was the most marketable good that gradually gained universal acceptance and thus became money. Its natural qualities as a noble metal, its use as ornaments and jewelry, its easy divisibility, great durability, storability, and transportability made it well suited to serve as money. The ancient Chinese used gold coins some 3,000 years ago. The merchants of ancient Greece made payments in gold and silver coins some 2,500 years ago. Even money substitutes were payable in gold. Papyrus notes and clay tablets promising to pay gold on demand were known already in the ancient world.

While gold-producing countries export gold and import goods and services as long as the mines are productive, most fiat- issuing countries face narrow limits in their ability to export their money. They may be able to expand their stock of money at modest rates, without alarming the international public. The balance of trade may turn "unfavorable" as people tend to buy more foreign goods. But as soon as they lose their faith and trust in the currency, the balance of trade reverses and, in Mercantilistic terms, turns rather "favorable." During the height of the hyper-inflation in Germany in 1922, the people eagerly exported all kinds of goods, including their valuables, in exchange for gold and convertible currencies. The German balance of trade was very "favorable."

As the issuer of the world standard money, the United States is subject to the same kind of limitation as other fiat-currency countries, but the scope is much wider; it is the world. It may engage in modest rates of expansion and import more goods than it exports. As long as the financial world maintains its trust in the value of the dollar the dollar standard will remain secure. But if it should ever lose this trust, the balance of trade would soon turn very "favorable."

The value of the fiat dollar rests solely on its function as money. It relies on confidence and trust in the ability and integrity of the government officials who issue and manage it. If this trust should be tarnished for any reason, the value of the U.S. dollar would plummet. If it should be completely lost, the dollar would soon cease to function as money as the Continental Dollar did in 1780 and many other fiat currencies ever since.

The market value of both, the metal gold and the fiat dollar, is affected also by the quantities offered, that is, by their supplies. During the age of the gold standard, the quantity of gold coming to the market was narrowly limited by the costs of mining, which depended essentially on the productivity of the gold mine. The quantity of fiat dollars and all its substitutes from M1 to M3 is solely determined by the discretion of the monetary controllers and regulators who are appointed by officials and politicians.

Guided and prompted by the Federal Reserve governors, American credit institutions apparently expand their credits at an annual rate of some 10%. The stock of currency outside banks, demand deposits, time deposits, and euro dollars in American banks, commonly called M3, have risen from $5.4 trillion at the end of 1997 to approximately $7 trillion today (November 15, 2000). While consumption is booming and savings are dwindling, aggregate debt has soared from $15.22 trillion to some $18.4 trillion (Federal Reserve Bulletin, November 2000, p. A13). The net foreign indebtedness is estimated at more than $1.6 trillion, or some 17% of Gross Domestic Product. The interest on this debt obviously magnifies the current-account deficits.

The deficits are made possible by large surpluses in the capital account. In recent years foreigners have made heavy investments not only in the booming stock market but also in American obligations, especially U.S. Treasury notes and bonds. In a world-wide process of economic globalization they have acquired control over numerous American corporations and bought some real estate. They are attracted not only by the ready availability of dollar funds in international money markets but also by the relatively high rates of American productivity, by high rates of interest and low rates of inflation. Their investments in American funds and facilities lend support to the dollar and finance the trade deficits.

The rapid technological changes especially in information and bio-technology attract much foreign capital. American capital markets are by far the largest and most liquid markets in the world. And American monetary policies have gained world-wide credibility in recent years. All these reasons point to the growing confidence of foreign investors in the United States as an investment area. They raise the old Mercantilistic question whether the huge trade deficits really are a symptom of economic weakness or actually an indication of special attractiveness of the American economy. Actually, they are a distinctive feature of the world dollar standard.

The eminent position of the American dollar in world trade and finance undoubtedly justifies a modest deficit. But the present levels of debt and deficit and the dependence on foreign investors alarm this observer. If the booming economy should suffer a readjustment and the returns on their investments should disappoint, the stream of capital undoubtedly would reverse and cast doubt on the stability of the dollar. The risk of a painful readjustment not only of the American economy but also of the global economy is growing rapidly with the growth of American debts and deficits. In crisis and decline we must brace for rising rates of interest, a falling international value of the dollar, and large losses in equity markets. American economic growth rates would fall drastically and a recession would descend over the world economy.

No one can time such a scenario. In the meantime we may cling to the hope of a slow readjustment and a soft landing.

Hans F. Sennholz

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