Donald Trump And The Trade Deficit Fallacy

I think I've picked on Bernie Sanders enough lately, so how about somebody else?  Donald Trump comes to mind.

I was watching a news show last night, and they were playing a video of a speech that Trump had made yesterday on the battleship Iowa in Los Angeles harbor.  Here's a clip of the speech.  As I tuned in Trump was in the middle of things and starting to talk about one of his favorite subjects, trade deficits.  The following appears starting at about 8:30 of the clip:

What is the United States trade deficit with Mexico, Japan and China?  Let's start with China.  Almost $400 billion per year.  If you have a company when you're losing $400 billion you've got to do something very fast.  We don't.  We've been losing hundreds of billions of dollars per year, frankly for decades.  It's not going to happen any more.

Wow -- Donald Trump thinks that a country like the United States, issuing a reserve currency and running a trade deficit, is like a company losing money.  I would have said that running a trade deficit for such a country is equivalent to a company making money.  It's very hard for me to get my head around Trump's apparent level of incomprehension and confusion.  Where to start?

Well, what does it mean for the United States to run a $400 billion trade deficit with another country?  Very simply, after netting out everything else, it means at the end of the year the United States ended up with $400 billion dollars worth of real goods and services produced by the other country through hard work and sweat, and in return the other country got $400 billion face value of non-interest-bearing pieces of paper created out of thin air at essentially no cost by the Federal Reserve system.  Now, who came out ahead?  If you're struggling with this, think of it as people rather than countries.  Suppose you (like the Fed) are given the magical ability to issue unlimited amounts of money that everybody else will somehow take in payment for goods and services.  In a given year, you spend a couple of minutes running a photocopy machine to produce a few million worth of your money, and then you buy yourself a nice mansion, a few luxury cars, and a couple of fur coats for the wife.  Who came out ahead -- you, or the people who worked thousands of hours to make all that stuff and sold it to you and got nothing in return but your scrip?  And, playing out the analogy further, the people who got your money could theoretically use it to buy something back from you, but by hypothesis they are never actually going to do it (because if they did, then you wouldn't have any trade deficit any more).

More broadly, the power to issue money is probably the most jealously guarded perk of governments and sovereigns.  Why would this be a carefully-guarded perk if it's a terrible detriment?  The power to issue money is the power to buy stuff without work or effort, not even levying a tax if you are a government.  Of course that's a benefit, not a detriment, to the money issuer.  Certainly, no one gives up the power to issue money if they don't have to.  Now, you do have to be somewhat judicious in using this power.  Within your country, you as sovereign can compel everyone to accept your money; but if you just flood the place with new currency, you'll soon find yourself in an inflation, and then a hyperinflation, and you can kill the goose that laid the golden egg.  Outside your borders, you need to be even more judicious.  You have no ability to compel anyone to take the money, so your ability to go on for years running trade deficits financed only by your own currency depends on nurturing the confidence of your trade partners that you are not going to hyperinflate the currency.  If you are Venezuela and you hyperinflate your currency, no one outside your borders will take it,  and then you need to get your hands on some reserve currency issued by someone else if you want to buy anything.  On the other hand, if you are issuing a reserve currency (meaning only a currency such that trade partners are psychologically willing to accept it), then you're golden.  As long as you are reasonably careful about it, you can go on essentially indefinitely consuming more than you produce.  You are doing a service to the world providing it with a relatively stable international money supply, and the grateful world compensates you to the tune of hundreds of billions of dollars worth of goods and services per year.

The United States has an incredible advantage in that, as irresponsible as we are in managing our money supply, virtually all the other countries are even more irresponsible.  (An exception is Switzerland, but they don't have nearly a big enough economy or enough money in circulation for the currency to act as a world money supply.)  So even as we run large trade deficits, our dollar has been appreciating in value against almost all world currencies for the past several years.  Essentially, that means that the dollar is acting as the world money supply and the world needs the liquidity.  The United States makes literally hundreds of billons of dollars per year (last year it was $505 billion according to the Economic Policy Institute) by getting to act as a reserve currency for the world.   That $505 billion is what is otherwise known as the trade deficit.  One way of looking at it is that it pays for almost all of the defense budget.

Admittedly, Donald Trump is far from alone in being completely confused about the significance of a trade deficit.  Certainly, almost no journalist understands this subject, and the number of newspaper and magazine articles equating higher trade deficits with "bad" or "worsening" and lower with "good" or "improving" is way too many to count.  And I have no idea how many of the other presidential candidates have any good grasp of this either.  Most of them just keep their mouths shut about the subject.   But Trump has somehow chosen to take a subject that he knows nothing about, and where everything he says can be shown to be 180 degrees wrong to anyone who pays attention for even two minutes, and make this a centerpiece of his campaign.  And then there's this (from about 10:00 in the video clip linked above):

The leaders of Mexico, Japan, China and every other country that we do business with -- they're smarter, more cunning, sharper than our own leaders. . . .

Well, if Trump is out to demonstrate that he is "smarter" and "sharper" than the geniuses from Mexico, Japan and China, he's going to have to do a lot better than his pronouncements to date on the subject of trade deficits.  Our current leaders certainly can't claim credit for getting us into the excellent position we currently find ourselves in as reserve currency provider to the world, but at least they haven't intentionally destroyed that position (yet).   If, as he claims, Trump is a really great negotiator, maybe he'll end us up in the position where the Chinese yuan is the reserve currency and instead of them paying us, we'll pay them $500 billion dollars a year for the service of providing the world money supply.  Way to go Donald!  Would it be even better if we paid them $600 billion?