Actually, I hacked off the summary of the opposing view, the B.S. Here's how it really works:
Consider an American trading with a Japanese citizen (we could just as well take a New Yorker trading with a Californian). Suppose that the American values a Japanese television set more than a particular piece of machinery which he has produced, and at the same time, the Japanese values the piece of machinery more than the television. If such is the case, they will exchange. This, of course, is simple barter—goods are exchanged directly for goods—and there is no monetary intermediary. But notice that no one has a “deficit” in this transaction—both parties are satisfied that they have gained more than they have given up.
Of course, very few barter exchanges actually take place. It would be difficult for the person desiring the TV set to find a person in need of the particular machine tool which he had to offer in exchange. Rather, the exchange is facilitated by the use of money, which allows the machine tool manufacturer to sell his product to anyone who wants it and then use the money to purchase the specific good (in this case a TV) from the Japanese producer. The Japanese producer can convert these dollars into the American product (in this case a machine tool) which he desires.
Although these individuals do not exchange directly, but through several intermediary buyers and sellers, the exchange is in principle the same as if they did. Ultimately the good produced by the American “pays” for the good received from the Japanese, and the Japanese good “pays” for the good received from the American. In other words, exports pay for imports.
But how then is a trade deficit possible? If in each exchange both parties are paying via goods and services, how can there ever be a national imbalance of trade? Why would foreigners agree to give up their products to us if they are not receiving American goods and services in exchange?
The answer is that they do not. Since each party trades only to gain, the difference between the value of the tangible or real goods which are given up by the “surplus” country and the value of the real goods which are received must be made up of other types of valuable goods. Each trade must balance; the deficit of real goods must be countervailed by a surplus of another type of exports.
And it is. The difference is made up of a net transfer of dollar claims from American individuals to foreign individuals. The trade deficit, which is more accurately called the merchandise trade deficit because it includes only the real goods traded, is possible only because on a net basis foreigners are willing to accept dollars in exchange for their goods and services, and temporarily hold these dollars. In other words, the U.S. currently is running a “surplus” of dollar exports with the rest of the world.
Why would they do that? Well, with some further ado:
The other major factor enabling America’s consumption to exceed its production is the Federal Reserve’s policy of monetary inflation. In any inflation, the individuals who initially possess the newly created money gain the maximum benefit. This has been the case in the international arena where, because of dollar inflation, individual Americans have found themselves the initial recipients of new money.*
Having increased nominal incomes, but not wishing to increase their individual “cash balances,” Americans have spent this new money for real goods, either domestic or foreign. New dollars spent on domestic goods tend to bid up domestic prices, and foreign goods (which have not yet been bid up) become more attractive to American consumers. Eventually dollars pour abroad in exchange for foreign goods. Inflation of this “world currency” has allowed Americans to bid goods and services away from other international buyers.
On net, Americans have been trading dollars for real goods because, for a number of reasons, they value the foreign goods more highly than their dollars. At the same time, on a net basis, foreigners are valuing the dollars they receive more highly than the real goods they are giving up. Can we say which party is getting the better deal? To do so would suggest that one is either irrational in its dealings or does not know its own best interests.
*And the money distributed by Fed policies doesn't hit all recipients simultaneously, contrary to what my beloved Dave Thompson stated the other night. The Fed doesn't have magical powers. The first recipients of the money go out and buy stuff with it, bidding up the prices of said stuff. The last recipients of the new money are the poor who get poorer. [Though, if you're getting a welfare check, you've actually been put at the front of the line. You're a government favored consumer - except for the fact that the amount of money you get is completely dependent on the whims of the politicians.]
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