2005 March 06 Sunday
Warren Buffett Warns Again On Size Of US Trade Deficit

I agree with Warren Buffett that the size of the US trade deficit is injurious and an urgent matter.

"Americans end up owning a reduced portion of our country while non-Americans own a greater part," he writes. "This force-feeding of American wealth to the rest of the world is now proceeding at the rate of $1.8bn daily."

"Consequently, other countries and their citizens now own a net of about $3 trillion of the US. A decade ago their net ownership was negligible."

I do not buy the arguments that we shouldn't be worried and that the market will work it all out. No, this can not possibly be a net benefit or a neutral development for the United States.

Will America become such a debtor society that many of us will work for foreigners who will own the means of production?

“A country that is now aspiring to an “Ownership Society” will not find happiness in – and I’ll use hyperbole here for emphasis – a “Sharecropper’s Society,” added Mr Buffett. “But that’s precisely where our trade policies, supported by Republicans and Democrats alike, are taking us.”

Bufffett is afraid of an eventual adjustment in currency rates that becomes so abrupt that a political and financial crisis could ensue.

"Without policy changes, currency markets could even become disorderly and generate spillover effects, both political and financial," Mr Buffett warned. "Such a scenario is a far from remote possibility that policymakers should be considering now," the billionaire said, though he conceded policymakers' "bent, however, is to lean towards not so benign neglect".

Should we worry? I think so.

At the time I'm typing this Buffett's letter for 2005 hasn't shown up on the Berkshire Hathaway web site. I'll try to update this post when it does.

Buffett previously wrote an essay about Squanderville and Thriftville where he proposed a system of Import Certificates to bring the US trade deficit under control.

The time to halt this trading of assets for consumables is now, and I have a plan to suggest for getting it done. My remedy may sound gimmicky, and in truth it is a tariff called by another name. But this is a tariff that retains most free-market virtues, neither protecting specific industries nor punishing specific countries nor encouraging trade wars. This plan would increase our exports and might well lead to increased overall world trade. And it would balance our books without there being a significant decline in the value of the dollar, which I believe is otherwise almost certain to occur.

We would achieve this balance by issuing what I will call Import Certificates (ICs) to all U.S. exporters in an amount equal to the dollar value of their exports. Each exporter would, in turn, sell the ICs to parties -- either exporters abroad or importers here -- wanting to get goods into the U.S. To import $1 million of goods, for example, an importer would need ICs that were the byproduct of $1 million of exports. The inevitable result: trade balance.

Because our exports total about $80 billion a month, ICs would be issued in huge, equivalent quantities -- that is, 80 billion certificates a month -- and would surely trade in an exceptionally liquid market. Competition would then determine who among those parties wanting to sell to us would buy the certificates and how much they would pay. (I visualize that the certificates would be issued with a short life, possibly of six months, so that speculators would be discouraged from accumulating them.)

By putting forward this proposal Buffett is basically saying he doesn't trust the currency market to set currency values at levels that will balance trade. Well, he is right after all. Otherwise the US wouldn't be moving to bigger and bigger record trade deficits. The US achieved a record $617.7 billion trade deficit for 2004 which was 24.4% above the previous 2003 record of $496.5 billon. This is insane. We also have a large government deficit and unfunded old age liabilities calculated to be in the neighborhood of $70 trillion by one accounting.

Share |      By Randall Parker at 2005 March 06 09:10 PM  Economics Political

crush41 said at March 6, 2005 10:13 PM:

A problem I see with Warren Buffet's idea is that it would hammer small business in the US. There's no way they could get a hold of those certificates, and consequently they'd be unable to get much of anything from overseas.

Randall, what are your thoughts on the decreasing value of the dollar? It's going to lower the US standard of living but help move towards balanced trade. I guess that's essentially what Buffet's idea would do as well.

Randall Parker said at March 6, 2005 10:38 PM:


There'd be a market in the certificates. The market would be enormous and highly liquid. It would be like a currency market. In fact, the Import Certificates would function like a currency. 1000 IC units might even cost $1000.

The decreasing value of the dollar has not gone far enough to stop the trade deficit in part because it does not apply to all currencies. The deficit with China was $124 billion in 2003 but grew 30% in 2004.

John S Bolton said at March 6, 2005 11:46 PM:

The plan seems to miss the point that the trade deficit is financed by central banks, mainly that of Japan, in order that their export manufactures not crash and wreck their economies. The savers of those countries, especially in Japan, are having their money replaced with US gov. securities, which can never be paid off to them. We're getting free imports, and shutting down our manufacturing, so that theirs can grow, or not decline. The overall economic imbalance is so extreme that it does not allow for repayment of the securities by means of future trade surpluses, as, for example, in manufactured goods, with those countries. If it is just that way, we are getting foreign aid of hundreds of billions a year; an unsustainable situation. It could be stopped, though, by telling those central banks that they may not acquire dollars beyond certain limits relative to the volume of their trade with us, and threaten them with consequences, such as taxation of the amount over the limits. This would prevent export finance bubbles from starting up, and then needing to be further subsidized, to avoid the down cycle that hits when the export growth comes to a limit.

PacRim Jim said at March 7, 2005 1:22 AM:

Other factors to consider: Once Iraq exports oil at 100%, will the U.S. save tens of billions by increasing the supply? Will access to U.S. markets and tens of billions in U.S. debt moderate China's ambitions? Will Americans stop buying Chinese goods at the first sign of Chinese belligerence toward the U.S., thereby throwing China (and Wal-Mart) into depression? Will nanotechnology obviate imports? Will biotechnology increase U.S. exports exponentially? Do not linearly extrapolate into the future America's trade imbalance. Events have a way of abruptly changing trends.

noone said at March 7, 2005 4:33 AM:

The weak point of the whole free trade argument:how can you trade if you have nothing to trade?

We have become the Heir who has run thru the trust fund money,mortgaged the mansion to the hilt and is now selling off the art,silverware and family jewels to maintain a lifestyle we can't really afford.

Eventually we'll run out of assets to pawn,and then....?

Stephen said at March 7, 2005 4:54 AM:

A sign of things to come happened a couple of months back when the head of the South Korean Reserve said that the bank was rebalancing its mix of foreign reserves by reducing their US dollar holdings (SK is something like the 5th biggest holder of US currency). When the currency traders found out there was talk of a run on the dollar which was only remedied after some frantic phone calls from the US to SK, followed by an emphatic statement by SK that they had no plans to reduce US dollar reserves. This is also one of the reasons why the US will happily dedicate 100,000 of its soldiers to defend SK.

Invisible Scientist said at March 7, 2005 9:36 AM:

The Import Certificates is a brilliant idea. But note that one of the main functions of the
US dollar is that it is basically the international currency many raw material exporting countries accept.
The reason they accept the US dollar is because the US is believed to be a reliable, stable and open country.
I am not sure that the currencies of China, Korea, or even Japan have attained that level of credibility to
bypass the dollar. Even the euro may not be able to replace the dollar.

In any case, the Import Certificates would be tantamount to trade barriers, and it would
almost certainly cause a depression in all the export oriented countries like Japan, China, Germany.
Additionally, there are very few American companies that manufacture at home, and so the price
of many crucial items like computer memory chips, LCD monitors, shoes, watches, would skyrocket, leading
to strong inflation.

Before we start the Import Certificates, we must make sure that there are enough US based factories
that are ready to start production when the new trade restrictions are imposed. One way to start local
factories, is to give tax breaks for companies that manufacture inside the US. For instance, reduce the
tax rate to 10 % or even 5 % for those companies that are producing inside the US.

Randall Parker said at March 7, 2005 10:45 AM:

Invisible Scientist,

The import certificates could be eased into gradually. Start out with, say, $1 spent on an IC would buy $1.50 of imports. Every year knock of a nickel or dime to very gradually bring the trade deficit down. Therefore the IC system would not have to be disruptive.

We could even exempt some goods from such a regime or exempt services. But then what is in the regime would have to be scaled back even further.

crush41 said at March 7, 2005 2:25 PM:

Will access to U.S. markets and tens of billions in U.S. debt moderate China's ambitions?

Does anyone have a clear answer to that question?

Additionally, there are very few American companies that manufacture at home, and so the price
of many crucial items like computer memory chips, LCD monitors, shoes, watches, would skyrocket, leading
to strong inflation.

That's what I was trying to get at--when items like these come into shortage due to low domestic production, the big mncs are going to be able to buy up the certificates and import the items to bridge the shortage. I'm not sure smaller domestic-only businesses would be able to compete, because the ICs would be tough to come by, even at a flow of $80 billion per month.

Randall Parker said at March 7, 2005 2:48 PM:


There are a lot of wafer fabs in the United States. Labor costs are not always the decisive consideration for where wafer fabs are located becaues the capital costs for each fab are so enormous.

Look, the dollar just fell 30%-40% against some currencies. The IC system essentially would simulate a further dollar fall and would even do it against the Chinese Renminbi (sp?). It would not prevent small companies from importing goods at all. They would just have to pay more for imports. But they would not in all cases have to pay for the full increase in import price since many would find domestic sources.

But few electronic components are being imported by small companies. I do software development work on special electronics boxes for use by engineers. We buy parts from big distributors. We aren't going to import 10 or 20 FPGAs from Taiwan or Japan. That'd be nuts. We'll buy them from electronics distributors. We don't even know where most of our components come from. Also, we build our boxes here and use circuit board populating companies that are in the US. You can go into factories around LA that have lots of automated equipment for placing pieces (chips, resistors, etc) on cards. I bet these sorts of factories exist in other parts of the country as well. Surely Silicon Valley has such places.

BTW, Dell does the bulk of its manufacturing in the US. They think hands-on labor costs are such a small fraction of assembly costs that they'd lose from shipping costs and shipping delays if they manufactured abroad. Dell is kicking the asses of all their competitors who moved assembly abroad.

PacRim Jim said at March 7, 2005 2:57 PM:

Once we have nanotech fab appliances in our garage, we'll be able to manufacture almost anything. Who'll need consumer product factories, workers or imports? I read the nanotech blogs and they're working on desktop factories for components. Early stage development, though.

Luke Lea said at March 7, 2005 4:46 PM:

Randall: My current take on the subject is that China is parking the lion's share of its savings in America nowadays because they don't trust their own banking system. But still they are a very poor people, and eventually, as their domestic financial insitutions mature, at least hopefully, they will start to spend that money on themselves, at which point the trade deficit will turn. But that could be years down the pike. In the meantime, hard as it is to believe, capital is likely to remain plentiful in this country and interest rates low -- which means the stock market will also stay higher than it would. Of course I'm probably wrong about all this, but at least it makes sense to me.

Invisible Scientist said at March 7, 2005 5:44 PM:

Like I said above, new tax breaks for manufacturing based inside the United States,
would be very helpful. For some areas of manufacturing competing with low wage jobs abroad,
cut the corporate taxes to 5 %.

Stephen said at March 7, 2005 6:47 PM:


Every one who volunteers to pay more for the things they buy, take one step forward.

Thank you for impoverishing yourself - your country salutes you.

Stuka said at March 7, 2005 8:24 PM:

The idea isn't to pay more, but to buy less.

Stephen said at March 7, 2005 9:00 PM:

I think the idea is to buy locally made goods & services rather than imports. The problem is that people buy the imported good because its a cheaper substitute for the domestic equivalent. Once the import certificates are 'spent', people will have no choice but to buy the more expensive local product.

Chris said at March 8, 2005 12:47 AM:

I run a small business in the U.S., and I am rather sympathetic
to Warren Buffett's freely salable Import Certificates proposal.
At the same time I am not sure it will be easy by any means
to implement.

My sympathy may be influenced by the following:

1. I am concerned that because the United States
(by which I mean the combination of government and private sector)
is borrowing and selling off its capital at a total rate of 5%-6%
per year (greater than GNP growth), and increasing that rate at about 1% per year, we are setting ourselves up for trouble in the future,
i.e. national poverty. At this rate we could be the next
Argentina. My country's politicians are acting like the
United States is too stupid to live. This bothers me since
my country is the United States.

2. A significant percentage of my business' sales are exports
out of the U.S., much more than our direct imports.

I suppose possible shortcomings of Buffett's proposal include:

1. Record-keeping difficulties and fraud could be significant
problems. My business would not have much difficulty tracking
our exports and imports. But I can imagine some businesses with
operations spread across various countries (both inside and outside
the U.S.) arranging to have their owned subsidiaries selling
and buying goods across borders to and from each other at
artificially high and low prices.
Let me give an example to help show what I mean:

Suppose Company A *owns* a subsidiary B in the U.S.,
and a subsidiary C in China.

Company A can tell its subisidiary C in China to sell PCs for $1 each
to its subsidiary B in the U.S. B might sell the PCs for
$800 each in the United States. Because company A owns
both C and B, company A owns the $800 per PC
even though officially the PCs were sold to a U.S. company
for $1 each, officially requiring only $1 of Import Certificates
per PC.

Ownership structures and profit rules in modern business can be
rather complex and hard to objectively boil down to a simple
"American company" vs. "foreign company" ownership definition.
There can be different classes of ownership in the same business
or partnership, different classes of stock in the same corporation
with different privileges, etc.

Well, there's my 2c, and it's worth more than you paid for it. :-)


Chris said at March 8, 2005 1:03 AM:

> Every one who volunteers to pay more for the things they buy,
> take one step forward.
> Thank you for impoverishing yourself - your country salutes you.
> --Stephen

Remember that our country is borrowing massively to buy
some of this stuff. When you're buying stuff by running up
a big debt, the question isn't so much "pay more or pay less?"
but rather "pay *more now* or pay *much more later*?"

forget the effect of compounding interest. And once a debtor
owes a large enough amount, the creditors *will* boost the interest
rates if they possibly can--as they have against many countries
when the countries became heavily enough indebted.)

Michael M. said at March 8, 2005 1:35 AM:

The link is available at the site, it is just that it is given under the 2004 year because of differences between fiscal and nominal years.

I have to admit I am quite astonished at some of the above comments. One thing: the US is not losing its manufacturing base. "Shutting down our manufacturing"? "[N]othing to trade"? Astonishing. I see casual statements like these thrown about at various places, usually by those who have fundamental problems with capitalism, which I doubt describes the previous commenters. The US still produces a lot of stuff. In terms of manufacturing only, the percentage of real manufacturing output to real GDP has been roughly stable (see http://www.epinet.org/content.cfm/briefingpapers_bp149 . I can't seem to find a way to replicate their absolute year-to-year figures from the BEA, only the relative curves). There may be some job losses, which is the focus of discussion in the EPI link, but you really ought to be specific if that is your problem. Total manufacturing output doesn't seem to be, though it has been falling slightly in recent years, at least as a percentage of GDP. The job losses can also be attributed to such things as productivity increases, not just foreigners "stealing" "our" jobs (the link shows the effects of productivity and the deficit; I actually don't quite understand the EPI claim that the increased demand is independent from the cheapness of imports in their domestic versus foreign factors, maybe I misunderstand their terms).

As far as Mr. Buffett's and Mr. Parker's overall concern, I just can't understand the problem with a trade deficit, leaving aside the employment question, which I suspect is more complicated than what EPI says. I try not to be a complete ignoramus on economics, but whenever I read anything about the evils of trade deficits, I have to scratch my head. For instance, Buffett discusses the problem of applying Adam Smith's ideas by stating (page 20 of the pdf) "Note, however, that Mr. Smith's statement [on the benefits of international trade] refers to trade of product for product, not of wealth for product as our country is doing..." I would suggest, however, that it isn't wealth that the US is exporting, it is merely a piece of paper, whose worth fluctuates. To put it bluntly, if foreigners want to be suckers and keep giving us actual stuff for mere paper, that really seems like their problem more than ours. But if they wise up, our currency falls relative to theirs and stops buying so much of their stuff; in other words, we will begin to pay more for what we have been artificially paying lower prices on because of foreign bank intervention. We start paying what the stuff is actually worth as determined by a market, not foreign bank intervention. Of course, a cheaper dollar leads to more US exports and increases jobs and manufacturing, just like an artificially cheap renmimbi is doing for China now. Which seems to be what you all want.

I guess I'm just a free market lemming, but what exactly is the problem with trading paper for Chinese electronics? The main problem I see is too much governmental intervention making governments nervous causing them to want to interfere even more which leads to more governmental panic.... Of course, I'm only talking here about trade deficits; the budget deficit is another matter entirely.

Ned said at March 8, 2005 7:30 AM:

I think Buffet is essentially correct - the US is flirting with long-term economic disaster by continuing to run such a large trade deficit. This could lead to a currency crisis. But the IC idea is a cure worse than the disease. Think about what it would mean:

1. A huge new government bureaucracy, paid for by the taxpayers, to administer the program. Plus lots of enforcement goons (think IRS).

2. Massive price increases and lots of cost-push inflation (think gas prices are high now? - just wait!)

3. Retaliation against US exports by countries whose exports to the US are cut as a result of the program (trade sanctions are rarely unilateral).

4. Countries harmed by such a program, such as China and Japan, hold massive amount of US currency and might respond by dumping it, making a bad situation worse.

If you want to consider a country that has its trade accounts in order, try Germany - it runs a surplus every year. It also has 12% unemployment and almost no economic growth. In part, the trade decicit results from the rapidly growing US economy sucking in capital from abroad. But I don't think this negates Buffet's basic point - this situation cannot be sustained forever. I guess I'm just too much of a free marketeer to believe that we need a huge new government program to "save" us - it smacks of New Dealism.

Randall Parker said at March 8, 2005 8:53 AM:

Michael Messina,

If we could sell small amounts of paper to get large amounts of goods then that would be great. But those piecs of paper carry with them a legal obligation to some day pay up. What happens when that day comes?

Suppose the Japanese and Chinese stop buying US debt and suddenly start expecting to be paid. As bonds became due the US Treasury would still have to pay back the principal. Interest rates in the US would have to rise in order to attract more money to borrow. So capital costs in the US would rise dramatically. This would hurt economic growth and lower living standards.

Michael M. said at March 8, 2005 9:48 AM:

Mr. Parker,

I think I agree with your scenario completely. But here is my problem with the problem you suggest. If this is true, then it also seems true that interest rates and capital costs are artificially low now. And the corresponding economic growth and increased living stardards can then be seen as a gift from the Chinese. When they stop giving us these gifts, of course it will look worse than what it did just previously, but it doesn't follow that it is worse than it would have been had they not been giving us the gifts. Why look a gift dragon in the mouth? Should we forego go 4%/year real GDP growth now because of a future 1% growth year? Obviously I'm just making those numbers up, but how can anybody be sure anyway? I have to say that markets should figure this out, not central banks.

To specify my view a bit, the main problem I see is our Fed panicking in the scenario you suggest and inflating the currency to stave off an inevitable recession, which would only look as such due to the artificiality of the current situation, and making matters worse both domestically and internationally.

It seems to me that the problems you have are really that we have it too good currently, and if things work out the way they are supposed to in the market, we won't have it so good anymore.

Proborders said at March 8, 2005 10:28 AM:

Randall, since many people want to bring democracy to the world, how about a democracy tariff?

The Democracy Tariff would apply to all imports from countries that don't have free or sufficiently free elections (see below for an important exception). Goods from China would thus be subject to the Democracy Tariff.

The Democracy Tariff would not apply to raw materials or resources such as oil. Thus, oil imports from Saudi Arabia would not be subject to the Democracy Tariff.

Randall Parker said at March 8, 2005 11:28 AM:

Michael M.,

If the money we were borrowing today was chiefly going toward capital investment then perhaps your point about growing now versus growing later might be correct. But I fear the trade deficit is going toward Buffett's "Squanderville" where we just consume more goods. After all, if we can import more goods than we consume there is less need to invest in capital here.

It would be interesting to know what fraction of the US economy produces capital goods and what fraction of what we import are capital goods. Also, as the trade deficit has increased has the fraction of the economy going toward capital investment decreased or increased?

I look at this intuitively: there are goods that American producers are not going to try to develop because those producers know that Chinese competitors can make them more cheaply. So I suspect that our strong dollar is decreasing the incentive to do research and development and capital investment.

Randall Parker said at March 8, 2005 11:36 AM:


A Democracy Tariff is an interesting idea. I suspect the biggest argument that would be raised against it would be that economic development encourages democracy development and that therefore a tariff against non-democracies would reduce the chances those countries would become democracies. I am not sure I buy the argument. But I'm sure it would be made very loudly.

I also think business interests would fund enormous efforts against such a tariff. Plus, the tariff would probably violate various trade treaties we are in.

I am not sure the Buffett Import Certificate proposal would violate treaties. The IC proposal is like fixing the exchange rate of a currency and some countries do that now.

The other practical problem with introducing a Democracy Tariff is that it would be hard to determine what is a democracy. Is Russia a democracy? It has elections. But the press is becoming steadily less free and Putin has revoked democractic selection of provincial governors.

I think a freedom tariff that adjusts for press freedoms would more precisely target countries to become more classically liberal. But I'm not sure the result would be to encourage more classic liberalism.

GUYK said at March 8, 2005 3:53 PM:

Sounds like just more government intervention to me. I already have enough paperwork and red tape to cut trying to run a business. Seems to me the biggest problem is that labor wants to make 30 bucks an hour but wants to spent it at Walmart--

Michael M. said at March 8, 2005 6:17 PM:

Mr. Parker,

It seems that worrying about capital goods is just a proxy for worrying about production capability, but as above manufacturing production as a percentage of GDP is similar to what it was before. I don't know what other sectors would be important to look at. As far as capital goods go, these are the data I gleaned from the BEA, all are 2000 chain-weighted dollars:

Capital Goods Imports ($ Billions):
2001: 306
2002: 300
2003: 317
2004: 372

Capital Goods Exports ($ Billions):
2001: 322
2002: 293
2003: 298
2004: 337
(both of these come from XLS files here and here)

Total goods imports ($ Billions):
2001: 1204
2002: 1248
2003: 1307
2004: 1449
(NIPA table 1.1.6 , you have to select annualized)

I couldn't find capital goods as a component of GDP anywhere or any less recent data for a better historical comparison. Anyway, the trade in capital goods is pretty balanced; they give us what we need and we give them what they need in a product-to-product way (almost) that Buffett likes. Maybe that has nothing to do with your point though. It looks like 30% of goods imports are capital goods. What does that number mean to you? Also, what would a Capital Goods/GDP ratio mean to you?

I fail to see what the trade deficit has to do with whether we are consuming too much or investing too little. Even without international trade, this could/would still be a problem. Regardless, here are the Gross Domestic Private Investment/GDP ratios from 1990-2004 (data calculated from the same NIPA table 1.1.6):

(1990)12.6%, 11.6%, 12.12%, 12.85%, 14.0%, 14.1%, 14.8%, 15.9%, 16.8%, 17.3%, 16.2%,15.5%, 15.7%, 17.0% (2004)

This shows that investment (as defined by GDPI, I will definitely admit ignorance as to whether this is the measure we should use) as a portion of GDP is high versus most of the 1990s and increasing recently (I just picked 1990 because it contains the previous recession, previous data going back to 1929 were mostly lower than 13% or so and sometimes much lower). So the answer to one of your questions seems to be that as the trade deficit has jumped up recently, so too has domestic private investment (I'm not going to argue casuality, the increasing trade deficit at least hasn't shown a deleterious effect).

This seems to support what I understand a trade deficit as meaning, at least in the absence of central bank interventions, which may complicate things. You buy a car from a German. The German considers what to do with the dollar you gave him (lets assume he doesn't want to buy something American, otherwise no deficit). He could trade it for Euros and consume/invest in his own country, or he can invest in the USA. Suppose he is a good German who isn't like a profligate spendaholic American. If Europe is not seen as a good place to invest and he doesn't want to consume, why would he want a Euro at all? He'll instead invest in an American business or in American debt. So a trade deficit is (or can at least sometimes be seen as) a signal that that particular country is a good place to invest, perhaps only relatively. Would you not see the US right now as a good place to invest (note I am not talking about currency trading)? A poster above talked about Germany's trade surplus and economic problems. When you look at the trade deficit in the above way, it sort of makes sense, though there may be other causes for Germany's case and I haven't looked at investment data for it.

Anyway, I just don't see in anything in these data that would suggest that something unsustainable and deleterious is happenening, from the US end anyway. Usually, trade imbalances work themselves out in currency shifts. The problem here is foreign central bank intervention; the market is not being allowed to work. But I still see the problem as more being theirs than ours.

John S Bolton said at March 8, 2005 8:29 PM:

This trade deficit is almost 180 degrees away from a voluntary situation, and says nothing about the attractiveness of the US for investment. It is forced saving in Japan and several other countries being thrown into US government paper by central banks, an act of aggression upon the savers and taxpayers of those countries. We are being smug receivers of stolen goods on a massive scale. Americans have minuscule incentive to save or not borrow to the limit, while interest rates are artificially held to negative or minutely positive real rates, by the hundreds of billions of stolen money flooding in each year. There is something wrong about fattening on what was taken by aggression from others. Even if there were nothing wrong with it, it can't last.

Randall Parker said at March 8, 2005 9:06 PM:

Michael M.

You state: "It seems that worrying about capital goods is just a proxy for worrying about production capability, but as above manufacturing production as a percentage of GDP is similar to what it was before."

If that is the case then manufacturing production has declined as a percentage of total goods consumed. After all, we are importing more than we are exporting and so we are consuming more than we are manufacturing.

Your tables show we were running a capital goods trade surplus in 2001 but we are now running a capital goods trade deficit.

You state: "I fail to see what the trade deficit has to do with whether we are consuming too much or investing too little."

Well, if we were producing as much as we are consuming then we would not have a trade deficit. In order to put an end to the trade deficit we either need to produce more (by either working more or boosting our productivity) to sell more to ourselves or abroad and/or we need to consume less. If we invested more we might be able to develop and deploy capital goods that would lower our own costs of production low enough that we'd buy more of our own goods and less imported goods.

But you raise the key question: Why do we have a large trade deficit? Is it because foreigners want to invest here? Is it because certain central banks are manipulating currencies to boost their exports? I've argued this one at length with a friend who is very well versed on macroeconomic matters. We both searched up a ton of data and beat the question around the bush a few times I think we both came out of the argument less sure as to the answers than when we started.

My problem with the "foreign money is lowering the cost of capital" rosy interpretation of our current situation is that there is less need for American businesses to invest in means of production for goods that can more cheaply be purchased abroad due to currency exchange rates.

I've seen Tyler Cowen over on the MarginalRevolution blog put forth a list of hypotheses on why the Japanese and Chinese governments buy so much US debt. Check it out. I think Tyler has also made a list of possible explanations for the trade deficit but I can't find that post.

Michael M. said at March 9, 2005 2:11 AM:

Mr. Bolton,

I don't think I disagree with anything you write above, though I do think there are multiple reasons for the deficit, and Mr. Cowen discuss them in the link from Mr. Parker. However, not buying a Japanese car because of the Japanese government's foolish policy does not help the Japanese people; unless it leads to some kind of revolution induced by economic means and thus help them in the long run. What if that revolution fails and we lose a trading partner completely? That would certainly help our trade deficit, but would we both be better off? I don't think so. Even though it can't last, that does not imply that our government and central bank should intervene by forcibly reducing our consumption.

Mr. Parker,

I think this last sentence is also a general response to you. You seem to argue that because a trade deficit exists, the US government has to do something. I think this is our main disagreement, though I suppose we also disagree as to who is hurt by it. When I said "I fail to see...", what I meant was that consumption versus investment as a percentage of GDP can be problematic even without international trade, and I wasn't talking about production which you brought up in response. From the numbers, investment as a percentage of GDP is at one of the highest rates it has been since 1929 (when the data begins). I presume higher investment is taken as a good thing by economists and indicative of sustainable economic growth (this seems intuitive), assuming that the actual investments actually make sense.

As far as capital goods, the difference in imports and exports now is tiny; without more historical data, which I was unable to find, I can't determine whether it is within historical ranges. But for you, any deficit represents a problem, both now and in the future. I don't see it that way, and I don't see data that actually show it to be a problem in real life (i.e. standard of living, employment, median income). As above, it seems that all the government can do is forcibly reduce our consumption of foreign goods. But how does that help? We may produce more of our own goods, but we will have less of them.

Again, I'm not arguing that this can last. I am arguing that the existence of a trade deficit does not necessarily imply a problem to be solved for the country with the trade deficit. It does not have any direct meaning in the well-being of citizens of that country. What data tells you that we are being materially hurt now or will be in the future? You seem to be saying that the existence of a trade deficit is the problem. Perhaps we are talking past each other, but to me, you are begging the question. Why is a trade deficit a problem? I see you as saying it is a problem because we are consuming more goods than we are producing. What am I missing? To me its unsustainability is irrelevant (in the absence of intervention, it should balance eventually), unless it can be shown that we would be worse off when it ends than we would have been if it never existed.

I guess intuitively, whenever I see the term "trade deficit" I actually think of it as a "goods surplus". We are getting more stuff than we are sending out. This to me is a sign of strength, not weakness. I just don't see the "killer stat" that shows it to be problematic. Does it adversely affect GDP growth? Employment? Median wages? Productivity? All of these things have been increasing recently (at least I think) even as the goods surplus has been shooting up. Unsustainability of a goods surplus to me is a natural outgrowth of the idea that trade is mutually beneficial: the more you trade, the closer the gap between your trading partner and you becomes. Now is central bank intervention a problem? Absolutely. Not only are the foreign bank actions problematic, but if they stop their intervention I fully expect our central bank to make matters worse. So I guess we agree that something bad will happen. But I don't think it is caused by the goods surplus itself, but by the mistaken and misguided interventions. And, of course, the central banks will not get the blame from the populace, free trade will.

Randall Parker said at March 9, 2005 9:48 AM:

Michael M.,

If the trade deficit is being caused by manipulation of trade and currency exchange rates by governments then do you think the odds of the trade deficit being harmful are greater or lesser than if the trade deficit is being made by the aggregate effects of decisions by lots of corporations and individuals?

I see the trade deficit as problematic for a few reasons:

1) We are definitely living beyond our means. That means a reckoning is in store some day.

2) The reckoning has the potential of being disruptive too in Warren Buffett's estimation. I think Buffett's estimation needs to be taken seriously because his judgement about markets has an incredibly impressive track record.

3) The foreign central bank bond purchases that help fuel the trade deficit help enable the government's living beyond its own means because those bond purchases keep interest rates down now. More debt is piled up by the government and the debt has to be paid down some day. I think it is unfair to the younger people that older folks benefit from this and younger folks will have to pay.

4) The interventions by central banks that make foreign goods cheaper knock domestic producers out of markets and therefore cut off the continued R&D by those producers in those markets. Once the dollar drops those domestic producers will have lost those markets and are unlikely to get them back.

Michael Messina said at March 9, 2005 8:37 PM:

Mr. Parker,

I don't know quite what you are asking in your initial question. In my opinion our trade deficit is not harmful (to us) unless our government/Fed try to arbitrarily "solve" it. You have still given me no data that shows harm from us having had a trade deficit for the past 20-25(?) years. It is bigger now. What does it actually harm? Employment? GDP growth? Standard of Living? All of these things appear to me to be fine. Show me something that isn't fine besides the number (Goods exported-goods imported). As far as the future, I discuss that in reponse to your second point. To respond to your points:

1. If we are "definitely" living beyond our means, then you must have some data that shows this (I discuss debt in point 3). A trade deficit is not equivalent to being in debt with a credit card company, which is what your phrase brings to mind, because the currency is not fixed!

2. I agree that Buffett's opinion is important to consider. But it is not sacrosanct. He himself discusses the difficulty in macroeconomic forecasts "And, again, our usual caveat: macro-economics is a tough game in which few people, Charlie and I included, have demonstrated skill." (page 21 of the report[pdf]). I have no idea how much he has studied the economics of fiat currencies and international trade; from reading his writing about this, I must say it seems very little (for most of his career, wasn't the US on the gold standard?). Then again, I haven't studied it much either, but nobody listens to me (luckily, you would say!). Simply because he is the master of investing does not mean I will allow myself to become rattled because he says I should be. If there is a problem now, it should show up in some data other than the number called "trade deficit". The problem that he sees in the future is a weaker dollar. But that is what is supposed to happen when you have a trade deficit. It is precisely this that makes the deficit balance. Why? Because it makes the imports of the trade creditor more expensive, and makes the exports of the trade debtor less expensive. This leads to increased domestic production and reduced importation. Trade deficits can persist (and have since 1980 or so) not only in the face of government intervention, but also as I discussed above, because some importers may just want to leave their money here. Buffett worries about this foreign ownership also, but didn't we already had that discussion in the 1980s with Japan? How did that work out? We didn't get taken over by the Japanese, and I am sure the workers at Toyota plants in Tennessee or wherever don't mind the fact that foreigners ended up investing here.

3. I agree that the government is living beyond its means somewhat; this does not imply that the overall nation is. The government could eliminate the budget deficit immediately if there was the political will. As far as overall debt to GDP, it is lower than it has been at times in the past (see here [pdf], it's unfortunately 2003, but the debt limit estimate in Fig. 2 is sort of an upper bound on the public + intergovernmental debt); anyway, how do you decide what is too high (see the comparison in Figure 3)? I would love for spending to be curtailed, particularly on entitlements, but that has nothing to do with the trade deficit. Buffett makes a point separating the two. The budget deficit is "between us Americans" while the trade deficit is between countries.

4. What data show that the United States is losing its production capability? Or that great swaths of industries are evaporating? The dollar is supposed to fall in order for the trade balance to be zeroed, as I mentioned in point 2. You can't just say "let's just export more", and not trading with foreign companies simply to reduce imports is foolish when they can produce the good cheaper than you can. The way to get rid of the trade deficit is to allow the currency to fall with respect to the currency of trading partner with whom you have a deficit.

To summarize what I see our discussion as: You say "This is bad and can't continue". I ask "What's bad?" and state "Well, it wouldn't continue if the currency market was allowed to work". You haven't addressed my first question with any data I can look up. And your answer to the second seems to be that any zeroing of the trade deficit by market forces (which would imply that the dollar falls relative to the renmimbi, for example) would be bad. Which leaves me scratching me head.

I guess there really isn't much more for me to say (I've certainly said more than enough! My words/expertise ratio has been at an unsustainably high level), so I probably make this my last comment. I think the only thing to be worried about is future interventions designed to "solve the problem", which basically makes me worried. The market is working exactly as to be expected in the face of the current interventions. If these are ceased (I can't comment on the effects of different methods or rates of ceasing them), then the market will eventually balance out or at least return to lower levels (as determined by the relative desirability of the US as discussed above).

Randall Parker said at March 11, 2005 6:04 PM:

Michael Messina,

What is bad about the trade deficit? Look at it from the viewpoint of a wealth accumulator like Warren Buffett. Buffett approaches investment with the goal of making his investments worth more each year. He looks for ways to choose and manage investments so that their profits and market values go up as much as possible each year.

Well, the people of the United States, by running a trade deficit that is about 6% of GDP, are probably becoming worth less each year rather than more. The total market value of America (including all physical assets and intellectual property) is probably not going up as fast as in absolutely dollar terms as the deficit is causing portions of it to be owned by or in hock to foreigners.

We become more wealthy when we increase our assets faster than we increase our debts. A large trade deficit makes it harder for us to do that.

Bob Badour said at March 12, 2005 3:09 PM:


The trade deficit is an unsustainable trend. Don't be fooled by the past long term stability of that trend. The longer the trend continues, the greater the upheaval required to undo the pressures it creates.

An earthquake analogy comes to mind. A fault might get a small earthquake every 10 years for 1000 years and then might go another 100 years without any earthquakes at all. The people living near the fault for the first 1000 years expect minor earthquakes and prepare for them. The people living near the fault at the end of 100 years of stability might look back on the previous century (their entire lifespan and more) and tell themselves that the earthquake threat has passed.

Unfortunately for the people living at the end of the 100 years of stability, they are going to experience an earthquake many orders of magnitude greater than their predecessors who had an earthquake every 10 years. The pressure continues to build until the earthquake finally releases it.

The American consumer and the Asian manufacturer are on adjacent tectonic plates. The US dollar reserves of Asian central banks and the Federal Reserve's low interest rate policies have artificially maintained stability at the fault--thereby allowing the pressure to build.

Frankly, I suspect the pressure has already built to the point where everthing will upheave considerably. I suspect the world's central banks will try to relieve the pressure but will do so too late. At that point, I have no doubt you will blame the central banks for their efforts to avert disaster instead of for their real misdeed which was to allow the pressure to build so high in the first place.

remo williams said at March 15, 2005 2:33 AM:

How do you figure the value of the US is decreasing?
The _real_ GDP average increase was
3% a year from 1973 - 1979
3% a year from 1980 - 1989
3% a year from 1981 - 2004

The media exaggerates crisis and booms, yet the real economic expansion continues at about 3% year after year. The trade deficit is mismeasured due to accounting differences with exports going through Hong Kong and due to undercalculation of US services being exported. Even when calculated correctly, it says nothing about the health of the overall economy. Just ask the Japanese...

The federal deficit is a minor problem which will eventually result in higher interest rates for a while. There is a possibility of a financial panic, but even that is easily weathered by longer term planning.

Randall Parker said at March 15, 2005 9:06 AM:


If our economy is growing at 3% but the foreign debt is growing at 6% of GDP then it doesn't take a rocket scientist to figure out that the value of the assets actually owned by Americans is decreasing.

Rick said at March 9, 2006 10:48 AM:

I think it will eventually adjust normally. The currency will trend down and imports will decrease. The only problem with the deficits is that we're consuming too much and forgoing investment in production. It will lead to a decrease of our wealth in the long term, but there won't be some cataclysmic crash in the dollar and doom and gloom out of the blue. IMHO

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