Saturday, March 20, 2004

The following is a letter to the editor of the Atlantic Monthly.

Lifted lock, stock and barrel (a complete flintlock, or older, rifle in other words--by the way, I'm still looking for a replica or real British musket, pre-1806) from Boudreaux’s Blog at FFF.

Tuesday, March 16, 2004

Dear Editor:

No concept in economics is more deeply and widely misunderstood than the trade deficit. Regrettably, Sherle Schwenninger’s “America’s ‘Suez Moment’” (Jan./Feb. 2004) only confirms this conclusion. Mr. Schwenninger commits the common mistake of equating a current-account deficit with debt. In fact, a current-account deficit is emphatically not synonymous with debt.

I’m writing this letter on my Sony computer, which I bought outright. I have full, debt-free ownership of the computer; Sony, in return, has $2,000 in cash. Even if Sony does not spend these dollars during the current period on American output - thereby contributing to the U.S. current-account deficit - debt is created only if Sony then lends these dollars to Americans, chiefly by buying corporate and government dollar-denominated bonds. If Sony instead buys shares of stock in American corporations, buys American real estate, or holds them as cash reserves, no American becomes indebted as a result.

Mr. Schwenninger overlooks an even deeper fact. Foreigners who earn dollars by selling goods and services to Americans, and who then invest these dollars in American assets, believe the American economy’s prospects to be rosy. This fact is so regardless of whether foreigners’ investments in America create debt or not. How many of us rush to buy equity in companies we believe are headed for bankruptcy? How many of us lend money to people and institutions we think cannot pay us back? How many of us hold currencies that we suspect will lose significant value?

The trade deficit is more likely to be evidence of economic health than a cause of concern.

Donald J. Boudreaux
Chairman, Department of Economics
George Mason University

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