Wednesday, July 26, 2006

Can't be said enough: "A Trade Deficit is Not a Debt (Nor is it Bad)"

Washington Post Columnist Steven Pearlstein's recent opinion, "A Winning Strategy for the Democrats: Barter for Free Trade" had a reader live discussion forum.

One reader, Silver Spring, MD, shared his misconception on the trade deficit:

For years I've struggled with this in my head... I'm an engineer.. logical, rational. Maybe as an economist, you can clear this up for me? My elected officials would have be believe that free trade, and in turn massive trade deficits, are "good for the country as a whole". Yes... I can buy cheap disposable goods at walmart for half the price I used to. However, simple point in fact trade deficit = wealth leaving this country... end of story, right? OK, so the chinese our financing our debts at the moment... OK, IOU's are building up, and wealth will SOON be leaving the country, same difference in the end. How is this good? I understand how it's good for the CEO's of companies that in turn do better, the small percentage of the nation holding stock in said companies... but the country as a whole? I just don't get it... seems like a pretty basic equation I learned when I was about 5 yrs old, money in - money out = wealth or debt, and at the moment, it equals debt... My rational brain is failing me on this one, please help explain? Thanx

Luckily for Silver Spring [no thanks to Mr. Pearlstein's response] , Coyote Blog has written the definitive discussion on why "A Trade Deficit is Not a Debt (Nor is it Bad)":
...Repeat please: The economy is not zero-sum. Never has it been so hard to convince people of a concept that should be so obvious. I used up bushels of electrons explaining why the economy is not zero sum here, but the short proof is easy: Look at the world in 1900. Look at it today. The world as a whole and most every individual is far richer. The fact is that economies create wealth every day, and free economies create a LOT of wealth.

At the heart of every argument that the trade deficit is bad is the mercantilist notion that the US economy is a bank vault leaking funds. But this analogy that seems to be in everyone's head is flawed. The supply of money or wealth in the US, in the vault, is constantly growing. If you really have to think of it as a vault, then think of what's inside as rabbits rather than gold bars. Does anyone doubt that if you start with a hundred rabbits and every year sent a few to China that you might still have more rabbits than you started with in the vault? A free economy is like a group of rabbits on Viagra. Even if the Chinese took billions of dollars they got from selling goods to the US each year and burned the money in a big bonfire, the US still would be growing in wealth...


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