This is an updated and expanded version of an article published in 2016.
A core idea that Donald J. Trump has embraced throughout his time in public life has been that the United States is losing in trade with the rest of the world, and that persistent trade deficits are evidence of this fact.
In this accounting, the $69 billion United States trade deficit with Mexico or $336 billion gap with China is something of a scorecard reflecting diminishing American greatness.
The vast majority of economists view it differently. In this mainstream view, trade deficits are not inherently good or bad. They can be either, depending on circumstances.
As the president’s emphasis on trade deficits puts the United States at odds with allies — in this case at the Group of 7 leaders meeting this weekend in Canada — the trade-offs in making this an overwhelming focus of economic diplomacy are becoming more clear.
Trying to eliminate the trade deficit could mean giving up some of the key levers of power that allow the United States to get its way in international politics. The reasons have to do with the global reserve currency, economic diplomacy and something called the Triffin dilemma.
What is the trade deficit?
Imagine a world with only two countries, and only two products. One country makes cars; the other grows bananas.
People in CarNation want bananas, so they buy $1 million worth from people in BananaLand. Residents of BananaLand want cars, so they buy $2 million of them from CarNation.
That difference is the trade deficit: BananaLand has a $1 million trade deficit; CarNation has a $1 million trade surplus.
But this does not mean that BananaLand is “losing” to CarNation. Cars are really useful, and BananaLanders got a lot of them in exchange for their money.
Similarly, it’s true that the United States has a large trade deficit with Mexico, for example. But it’s not as if Americans were just flinging money across the Rio Grande out of charity. Americans get a lot of good stuff for that: avocados, for example, and Cancún vacations.
If you want to think of it in terms of winners and losers, you could justifiably reverse Mr. Trump’s preferred framing: “Those losers in Mexico gave us $69 billion more stuff than we gave them last year. Ha, ha, ha. We’re winners.”
What does that have to do with savings and investment?
When a country runs a trade deficit, there is a countervailing force. Think back to our pretend countries. BananaLand has a $1 million trade deficit with CarNation. But that means that car producers in CarNation are sitting on an extra $1 million a year in income.
Something has to happen with that $1 million. If CarNation doesn’t want the value of its currency to rise, it has to take that $1 million trade surplus and plow it back into BananaLand. There are different ways it could do that. People in CarNation could buy stocks or bonds in BananaLand, or companies in CarNation could invest in factories in BananaLand, or the government of CarNation could buy assets directly.
In effect, the flow of capital is the reverse of the flow of goods. And the trade deficit will be shaped not just by the mechanics of what products people in the two countries buy, but also by unrelated investment and savings decisions. The cause and effect goes both directions.
So, for example, if a country enacts a giant tax cut that increases its budget deficit, it is effectively lowering its savings rate — which tends to increase its trade deficit.
That, of course, is exactly the fiscal policy choice the United States has made, so the tax cut passed late last year will tend to increase the trade deficit relative to its level if tax rates had remained unchanged.
But don’t trade deficits mean fewer jobs?
It is true that a trade deficit subtracts from a country’s gross domestic product. G.D.P. measures the value of goods and services produced within a country’s borders, so when a country is selling less stuff abroad than it buys from abroad, the country is making less stuff, and as a result there are fewer jobs. This piece of the Trump theory of trade is true.
But the flow of capital into the country — the inverse of the trade deficit — creates benefits that can be good for jobs, by encouraging more domestic investment.
This isn’t just an abstraction. It’s what has happened between the United States and China for the last couple of decades. China has had consistent trade surpluses, but it did not want its currency to rise in a way that would undermine its exporters. So money has flowed from China into the United States — both from the Chinese government’s purchases of United States Treasury bonds and more recently in the form of direct investment from Chinese companies into the United States.
When you see a headline about a Chinese company buying American hotels or factories, you’re seeing the flip side of the trade deficit Mr. Trump bemoans. (The same when a citizen of China buys a luxury apartment in a Trump tower.) Money flowing into a country is usually considered a good thing. It makes borrowing money cheaper, drives up stock prices and can mean more investment in new businesses.
So does a trade deficit mean fewer jobs? It depends on which force is more economically powerful: fewer jobs creating exports or investment dollars flowing into the country.
So which is it?
It depends on what the country does with the investment that comes in.
In theory, that money could go toward long-lasting investments with positive economic returns: new factories and equipment; education for the work force; new roads and bridges, or repairs and improvements to existing ones.
Unfortunately, how countries use these capital inflows is not always so fruitful. In the United States, the influx of foreign capital in the mid-2000s went in large part to fuel an unsustainable housing and mortgage bubble. Greece’s capital inflows in the same time period went to fund bloated public spending.
When the world is flinging money at you, it’s important to use it for something productive. It’s not that trade deficits (and the capital inflows that are their flip side) don’t matter — but just knowing the numbers doesn’t tell you much about whether they are good, bad or indifferent.
Wouldn’t it be better if the U.S. didn’t run a deficit?
It’s not clear that that’s even an option, because the dollar isn’t used just in trade between the United States and other countries.
The dollar is a global reserve currency, meaning that it is used around the world in transactions that have nothing to do with the United States. When a Malaysian company does business with a German company, in many cases it will do business in dollars; when wealthy people in Dubai or Singapore’s government investment fund want to sock away money, they do so in large part in dollar assets.
That creates upward pressure on the dollar for reasons unrelated to trade flows between the United States and its partners. That, in turn, makes the dollar stronger — and American exporters less competitive — than they would be in a world where nobody used the dollar for anything except commerce involving the United States.
The roughly $500 billion trade deficit that the United States runs each year isn’t just about poorly negotiated trade deals and currency manipulation by this or that country. It’s also, to some degree, a byproduct of the central role the United States plays in the global financial system.
There’s even a name for this: the Triffin dilemma. In the mid-20th century, the economist Robert Triffin warned that the provider of the global reserve currency would need to run perpetual trade deficits to keep the world financial system from freezing, with those trade deficits potentially fueling domestic booms and busts.
The key idea is that if Mr. Trump really wanted to reduce our trade deficits in a major way,he would have to have to rethink the very underpinnings of global finance.
If having the global reserve currency means bleeding jobs overseas, why keep it?
Be careful what you wish for.
There’s no doubt that maintaining the global reserve currency creates costs for the United States, namely a less competitive export industry.
But it also creates a lot of advantages. Lower interest rates and higher stock prices are among them (though they have the downside of also feeding debt-driven booms and busts). Even more important is what the dollar’s prominence in global finance does for America’s place in the world.
It helps ensure that the United States can afford to finance wars, and it gives the government greater ability to fight recessions and panics. A country experiencing a banking panic will see money sent out of the country, causing its currency to fall and its interest rates to rise. All that limits a government’s options for fixing the problem. In 2008, when the United States experienced a near collapse of the banking system, the opposite happened.
The centrality of the dollar to global finance gives the United States power on the global stage that no other country can match. It has enforced sanctions on Iran, Russia, North Korea and terrorist groups with the implicit threat of cutting off access to the dollar payments system for any bank in the world that does not cooperate with American foreign policy.
Part of what makes the United States powerful is the great importance of the dollar to global finance. And part of the price the United States pays for that status is a stronger currency and higher trade deficits than would be the case otherwise.
The debate over the trade deficit is about more than Mexico and China, cars and bananas, or winning and losing. It’s about what makes America great, and which of the country’s priorities should come first.
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