Comment by weel | Hacker News Reader

Comment by weel | Hacker News Reader

This is an entirely sensible piece. I'm not sure if it is relevant to hacking or to startups, but it is entirely sensible.

If A sells to B sells to C sells to A, then they have just created three trade deficits. This is why "the trade deficit with China" is an utterly meaningless concept. Maybe China sells things to the US, which sells things to Mexico, which sells things to China, or any other transitive combination, and voila, a trade deficit.

The only trade deficit that is somewhat meaningful is the trade deficit of a country with the rest of the world, all of it. Now even that trade deficit needs to be taken with a grain of salt. If the US has a trade deficit with the rest of the world, you have to wonder for a minute why on earth the citizens of all those other countries would be so happy to send goods America-bound and not to receive equal value in return. Whence their charity? How come the free lunch?

When a good economist smells a free lunch, s/he smells murky accounting. And indeed, there's murky accounting in the trade deficit. Oftentimes, services are not included. Even if they are, then investment isn't. It just so happens that the US is a good place to invest, relative to other countries, because it has a very well developed economic and financial system that can take advantage of capital well and bring high returns in capital-intensive industries. China, on the other hand, lacks the institutions required to make capital-intensive industries quite as lucrative, but it has cheap labor. Thus both countries specialize, but the Chinese investments flowing into the US bought with the money that Americans paid the Chinese to buy their goods--those investments simply do not count.

Hey! A deficit!

Is it a big deal?

Mwah... no.

Trade deficit of a country (the one vs the rest of the world) is equal to investment of other people in the country, trade surplus equals investment in other countries.

Why is this so? Imagine there are only two countries in the world, USA and Japan, and US has a trade deficit. This means Japanese manufacturers sell their goods and do not convert all of what they earn in yen, they keep some part in US dollars. These money are directly or indirectly invested in US: if people keep these money in the bank, the bank invests them. Sorry, I'm not precise, but I hope you get the point.

Now, it doesn't say if the investment is good or bad: the invested money can be happily consumed and the investor could get less or nothing for his money. It doesn't also say who owns (controlls) what: it may turn out that after a while some part of the US economy is owned by Japanese, depending on what they choose to do with their money.

Generally the U.S. has run perennial trade deficits with the rest of the world because people around the world have been essentially collecting dollars instead of spending them. They were for a long time considered the main "hard currency" other than volatile and politically-sensitive gold.

In other words, we would send dollars to country X and receive goods in return. Instead of sending back those dollars to us and receiving goods from us, they would stuff them under a mattress, or in their government reserve vaults, because their own local currency was not considered as trustworthy.

In recent years, foreign governments have begun viewing the euro as a strong, stable currency, and have been diversifying their reserves by getting rid of dollars and stocking up on euros. Two of the recent effects of that phenomenon have been a declining dollar (as with anything, its price goes down when there is a sudden flood of sellers), and high U.S. asset prices (because now the dollars are coming out of the mattresses and vaults, and being used to buy stocks and property).

Instead of sending back those dollars to us and receiving goods from us, they would stuff them under a mattress

Usually they take the cash and invest it in US Government Bonds or private stocks and bonds. This high demand for bonds means our government can offer them at really low rates, and there are still takers. (China has something like $300 billion of US Bonds.) This is an added bonus for us. In this way, our currency's primary status is kind of self-perpetuating. Our currency is backed in faith in the solvency of the US Government, and our Government can borrow money really really cheaply to deal with any crisis it needs to, keeping it solvent where other governments would fail.

(For anyone out there that is scared what will happen if the rest of the world started dumping it's dollar-back assets, remember that less than half of the 'National Debt' is owed to foreigners, and many of these countries use dollars to stabilize their own currencies, so this would amount to financial suicide for them.)

I guess the traditional way to get a free lunch would be to borrow lots of stuff and then go bankrupt.

Investments are captured in the current account (which includes the trade balance, factor payments and transfer payments plus a fudge factor for illegal and unaccountable capital flows). The current account deficit, not the trade deficit, is the more important and worrying statistic.

The trade deficit shows that the US is importing more than it exports, but the current account deficit shows that the US is spending more than it earns. The problem with a growing current account deficit is that an increasing proportion of US income (GDP) is required for factor payments (ie. interest/dividend payments to other countries for their investments in the US). This is basically what is meant when they say that the US is borrowing from the rest of the world. And obviously it isn't sustainable.

Oh, and in case anyone has things mixed up (I wouldn't expect it in this crowd, but you never know): no, trade deficits and budget deficits are entirely and utterly different things, no matter how often Lou Dobbs mentions them in the same sentence.

Wrong what your trading is important.

Let's say A, B and C all have balanced trade:

If A sells soda for 1USD to B then: A has a trade surplus of 1$. B has a trade deficit of 1$. C has balanced trade.

If B then sells apples for 1USD to C then: A still has a trade surplus of 1$. B now has balanced trade. C has a trade deficit of 1$.

If C then sells corn for 1USD to A then: A, B and C have balanced trade.

The problem is when B and C trade with something other than dollars. China is keeping a large quantity of USD on hand and not trading them which messes with the value of the USD.

It's not like China is sitting on a big mountain of Ben Franklins somewhere. If it is smart (and it is), it invests the dollars it is hoarding in US Bonds or some other very safe vehicle (US Bonds might as well be bulletproof, short of WWIII). The problem is that even though China is investing in dollar-assets, this isn't counted in the silly trade deficit figures.

I agree.

The US won't default on bonds anytime soon. But they are only bulletproof in terms of value when you measure value in US$ - and not in adjusted terms (inflation, purchasing power paritiy, exchange rate, etc).

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