Friday, October 22, 2010

Trade Deficits and Trading

There's been a lot of talk over the years about the trade deficit as concerns imports and exports. I understand that concept - we buy more than we sell, so money is leaving the country. I also understand, roughly, that that's a bad thing. Well, I used to understand that. Looking at a section of the previous link, there seem to be a lot of smart people that think trade deficits could be a good thing. That may be a topic for later.

I've been curious as to whether money is actually leaving the country, overall. This balance of trade really only covers the import and export of physical goods and real services, as near as I can tell. I can find no indication that the portion of treasury auctions purchased by foreign entities counts as either an export or import. This statistic also doesn't count profits and losses from stock trades, bonds, forex trades, etc.

Awesomely enough, some of that data can be found. It looks like I could spend a few years sifting through the data at the Treasury International Capital (TIC) site. It took me most of a day to read the FAQ! But, there's some absolutely great data, such as this grand total table of foreign transactions. And these grand total tables of foreign liabilities and foreign claims. And this other table of derivatives contracts stuff. There's a lot of information to read on how to use all this information. Then there's this table of everything (Flow of Funds Accounts) over at the Federal Reserve statistics site.

Perhaps you can see why I said I found a lot more information than I expected to. I still don't think this covers everything. For one, the FAQ says there are a lot of errors due to a variety of factors. And even with all these statistics being complete, I don't think they would be able to answer my question. I'm still not sure if these show any profitability in all these trades, and I'm almost positive they don't cover forex transactions, since that has an average daily volume of $3.98 trillion, and I don't see any figures with large enough values to cover that. I have to admit that I'm tired of looking into it at the moment. However, if anyone has the answer, or even just another piece of the puzzle, please do let me know in the comments!

1 comment:

Anonymous said...

Well, in theory, trade deficits are self-correcting because a sustained trade deficit will result in the value of the deficit nation's currency falling in value relative to that of the surplus nation. This primarily works due to a increase in demand for the latter currency and a decrease in demand for the former. Also, as a trade debt accumulates, there is also a shift in confidence away from the deficit nation's currency to that of the surplus nation. And, in theory, this will result in a price adjustment that will balance out the trade by making the deficit nation's exports more price-competitive.

But we all know that the real world is a far cry from theory, so it's worthwhile to see where this all breaks down. First and foremost, some currencies cannot be freely exchanged. Second, confidence and demand for a currency is not strictly tied to the trade balance. In our case, we have a (massive) extra reserve of both confidence and demand for the dollar because it is still the world's major reserve currency. Finally, and perhaps most importantly, it is subject to manipulation. Specifically, countries that buy a large amount of dollar assets (Treasuries, bonds, etc.) can artificially inflate the value of the dollar relative to their currency. An obvious example comes to mind.

As with all things in economics, it also helps to look at this with a scaled-down model. Specifically, just two people. If you and I have a "trade imbalance", it means that, basically, I'm letting you buy on credit from me--I'm lending you money. In most cases, as this goes on, the lender loses confidence in the borrower and as the IOU's pile up, they will become increasingly meaningless in the eyes of the lender and the lender will eventually stop accepting them, at which point, the trade balance reverses: if you think about it, a borrower repaying a lender is essentially the borrower running a trade surplus and the lender running a deficit, until that accumulated trade debt is erased. However, the lender has the option to keep accepting those IOU's, to basically continue letting the borrower buy on credit (in this case, loaning back to the borrower what the borrower just paid), and that's what China is doing essentially. And the mechanism of loaning back to the borrower what the borrower just paid is achieved by buying up debt--bonds, Treasuries, etc. Eventually, if this continues, it will end poorly for BOTH the US and China. And actually, for all countries and China, since they are doing this with everyone (the EU and Japan trade ministers have recently been publicly complaining about Chinese currency manipulations).

It is primarily through currency manipulations that the deficit is allowed to sustain itself, and to get an idea of the magnitude of Beijing's machinations, look at the (huge) discrepancy between China's nominal GDP and PPP GDP; a discrepancy that is simply unmatched among the other major nations in the world.