Don Boudreaux, whose department I hope to one day be smart enough to study in, has yet another post about investor nationality and the current account. He’s been making this point for a pretty long time, but it does bear repeating.
The current account is in deficit when foreign consumption of US goods and services (including equities and debt) exceeds US holdings of foreign goods and services (including equities and debt). “Trade deficit” is often used synonymously with the current account deficit. I don’t particularly like the term “deficit” in this regard, because it implies debt, and most of the current account imbalance isn’t debt, it’s foreign holdings of dollars. Foreigners have dollars because we’ve purchased things from them, we’re currently purchasing more from foreign sources than they are from us. So what?
Well, as Professor Boudreaux explains it doesn’t really matter all that much. A concern among the trade-imbalance Chicken Littles is that foreign banks will either stop holding their dollar reserves or stop purchasing US government debt. This is particularly a concern with regard to SE Asia. So Asian banks trade their dollars for Euros…so what? The only place those dollars can be spent is in the US, foreigners hold dollars because they are a stable currency that is unlikely to go away, if they trade dollars for other currency the folks who accept dollars only do so because they expect to be able to purchase things from the US with those dollars at a later date. If the SE Asian banks stop buying US government debt (which I don’t think is particularly likely, why would they?) Somebody else will buy it and be happy to. It may be US consumers, it might be other central banks in other regions, but somebody will. US bonds are stable, never get cancelled, and foreign folks know this. We can debate about whether we’ve alread got enough outstanding government debt (I think we probably do) but who holds it is irrelevant.
Why, then, is this so damn hard for people to understand? Why is there this feeling that we should always maintain a positive balance of trade? I think it’s a deeply-rooted cultural heritage of Mercantilism. Primarily this assumes that trade is zero-sum (not true, as Heckscher-Ohlin shows), and that national stability is dependent upon maintaining high national stocks of wealth in the form of bullion. Translate this forward a few hundered years, and you see an obsession with exports relative to imports and a desire to make sure that we’re bringing in as much cash as we can through the current account.
