The U.S. Department of Commerce estimates the U.S. trade deficit for October 2004 to be $55.5 billion, up 10% over the trade deficit of $50.9 billion in September and the monthly average deficit of $50.1 billion in Q2 2004.

This deficit reflects the position of the U.S. dollar as the world’s premier trading currency and is good news for U.S. consumers and exporters in Latin America and Asia. Since the U.S. dollar is the leading international trading currency, the trade deficit reflects globalization and the rise of a dollar world economy.

(See: [1] The Trade Deficit and Dollarization )

In Q2 2004, about two-thirds of the dollars that the rest of the world received from selling to Americans was spent on buying U.S. goods and services. Part of the remaining one-third was foreign savings in dollars, with part representing “float” from the use of dollars as the international trading currency.

Some say that the U.S. trade deficit means that Americans save less than the rest of the world. However, no one can be sure that the U.S. trade deficit truly mirrors the savings of non-Americans because there is no properly consolidated flow of funds accounts for the “rest of the world”.

( See: [2] Bank of Japan’s International Comparison of Flow of Funds Accounts)

The U.S. trade deficit is the result of the dollar’s role in a fiat-money system. Part of the deficit consists of “float” needed to grease the wheels of international commerce.

The opposite of “deficit” is not necessarily “savings”

When a Brazilian exporter sells coffee to the U.S. in exchange for dollars and then uses this money to buy wheat from an exporter in Argentina, who in turn uses the dollars to import clothes from Ecuador, and so on, the dollars may stay in the hands of foreigners indefinitely, giving the appearance of foreign savings, when, in fact, foreigners are spending this money among themselves as fast as they can.

Part of the U.S. deficit may, in fact, represent trades between foreigners that have not yet been settled — in other words, “float”.

World trade in goods and service in 2003 was about US$ 8.1 trillion and the U.S. trade deficit was about 7% of this total. In Q2 2004, at least half of the U.S. trade deficit was held in the form of extremely short-term, safe, liquid assets — bank checking and time deposits, repurchase agreements, commercial paper, and treasury bills — forms consistent with temporary investments pending settlement of international shipments of goods.

Given the longer “clearing time” of international trade transactions (compared to domestic financial clearings) and given the dominant role of the dollar in global trade, it seems possible that as much as half of the U.S. trade deficit may represent “float”, rather than “savings” of foreigners.

Comparing “savings” apples and oranges

Although the rate of savings of Americans, as a whole, appears quite low, this is certainly not the case for the top 1% of the U.S. population that has been accumulating wealth at a rapid rate.

(See “Bank of Japan Research Report).

Furthermore, Americans have an extremely high rate of home ownership. For 90% of the U.S. population, home equity accounts for about 27% of household wealth.

(See: [4] Rich and Poor)

In other words, the seemingly “moral arguments” against the trade deficit are not necessarily persuasive (e.g., “a penny saved is a penny earned”, and “better a borrower than a lender be” may be irrelevant).

Why we need to stop worrying and learn to love the deficit (while it lasts)

Even novice bankers know that although depositors may trade among themselves at a fast pace, each holding only small true balances, the “float” that arises because of the time it takes for transactions to clear, produces profitable permanent working funds for the bank.

Because there is no international currency backed by gold and because the U.S. dollar is the most popular international means of payment, widely held throughout the world, Americans, in the final analysis, must end up as bankers to the world and benefit from the “float” in international trade.

Until the world enters into depression, or there is a drastic shut-down in international trade, it is unlikely that the U.S. trade deficit will go away.

Something extraordinary would need to occur (like atomic bombs on U.S. financial centers) to cause exporters to refuse to trade in dollars. As things are now, the U.S. trade deficit keeps everybody happy and there is no incentive to change. Here are some of the beneficiaries of the U.S. trade deficit:

China and other countries seeking military power: Every billion dollars of U.S. trade deficit is worth ten thousand bombs on American factories. Peaceful deindustrialization may gradually transform the United States into a toothless tiger in twenty or thirty years. Pegging a currency to the dollar and encouraging exports to the U.S., builds industry and creates jobs in the exporting country, with collateral strategic military advantages.

American homeowners: The trade deficit provides funds for home mortgages while stimulating inflation. Over the long haul, the homeowner (assuming she has the good sense to get a fixed rate mortgage) benefits from inflated real estate values and the declining real value of loans.

Foreign workers: In developing countries with high unemployment, exports to the U.S. create jobs, while providing international currency that can be used to pay for goods produced by many other countries.

Foreign factory owners: For owner-managers of factories abroad, interested more in creating cash flow than boosting return on equity, U.S. trade deficits mean cash in the bank.

International exporters are happy to bill in dollars as long as the money they receive can be used to buy goods in countries throughout the world, or real estate or commodities in the United States, or international investments in the well-organized American securities markets.

The U.S. consumers are happy because dollars on deposit in U.S. banks (or reinvested by foreigners in U.S. securities) finance mortgages and consumer credit, permitting Americans to live at a high level. The U.S. government is happy because a large portion of trade deficit dollars end up financing the fiscal deficit, paying for foreign wars and domestic excess spending.

Fiat money in a service economy ensures inflation

The trade deficit can never throw the U.S. into bankruptcy for the simple reason that the “debt” is denominated in dollars and the United States Treasury controls the printing presses that guarantee an unlimited supply of dollars.

The dollar is fiat currency — the world is not operating under a gold standard. Even government debt held by foreigners is paid merely by the Treasury crediting someone’s dollar bank account, which means that banks will have dollars to reinvest — even in reissued government bonds. Funds for rollover of government debt are virtually guaranteed.

Americans also do not need to worry about running out of dollars with which to pay their debts or not having enough money to buy things from the rest of the world. Most of the United States is a service economy.

People work in government jobs, health care, education, transportation, commerce, and so forth. In a service economy, it is easier to adjust the money supply to the needs of the people than in an industrial economy based on factories with international competition.

In the U.S., most people do not compete in an international or even national market. The local dentist, dog psychiatrist, or ballet school teacher does not compete with others in similar lines in other cities, states, or countries. In local markets for services it is easier to raise prices. When the dentist raises her rates, so does the dog psychiatrist, and the ballet teacher.

The credit cards of the dentist, dog psychiatrist, and ballet teacher create new money needed to buy Thanksgiving decorations from China and electric toothbrushes from Malaysia. When foreign countries sell more to the U.S. than they buy, this creates the permanent financing needed to extend payment on credit card debt.

Inflation in the United States is much greater than official figures suggest.

(See: [5] Fiddling the CPI)

The trade deficit permits stores to be stuffed with low-cost merchandise, giving the illusion of relative price stability for things like food, clothing, and electrical appliances. However, in the sheltered service economy (college tuitions, medical care, and government services), inflation rages, while being seriously misrepresented in the Consumer Price Index.

What would it take to eliminate the trade deficit?

Because the trade deficit has been growing for over a generation, it should be clear that there is no built-in, cyclical, economic mechanism that will force a reckoning upon the American people (and the rest of the world). A possible end to the U.S. trade deficit might be a “historical discontinuity” — a “paradigm shift” unthinkable in current scenarios.

Here are a few “alternate worlds” without a trade deficit:

The Advent of Isolationist U.S. Economic Policy: New American leaders could promote policies that allow the U.S. to regain industrial dominance and move from globalization towards the protectionism that made the United States a great industrial power in the 19th century. Touchy-feely curricula of public schools and colleges may be replaced by tough regimes of science, math, ethics, history, and writing.

Tax codes may be revised to encourage scientists, engineers, and industrial entrepreneurs, while heavily taxing sports heroes, Hollywood celebrities, and lottery winners. An “entrepreneurs homestead act” might be passed, offering young people the capital needed to start their own businesses, with long-term control assured by permitting listing of non-voting preferred shares. Stock buybacks and option incentives might be outlawed, while dividends could be encouraged.

Corporate taxes could favor “productive enterprises” and intensive capital investment in industrial productivity, research, and development. Government could take steps to reward excellence and quality in manufacturing. Trade unions might be outlawed and tort lawyers severely curtailed. American youth might begin again to dream of science and invention, disdaining tattoos, body jewelry, and loud music for the pleasures of tinkering and developing products in their garages and cellars. Within a generation, America could become again the premier producer of advanced goods and service, with high quality and low prices that would create a trade surplus, while driving inefficient, cheap-labor factories in the third world into bankruptcy.

The U.S. Could Lose the War on Terror: Atomic bombs on large U.S. cities and financial centers could cause government to shut down ports, thereby eliminating the trade deficit (along with trade). Retaliatory atomic strikes on diverse cities in the Mid-East could bring on world criticism that drives the U.S. to renounce globalization and free trade, into isolationism and restricted international commerce.

Inflation and uncertainty as to the stability of the U.S. government could lead foreigners to insist that Americans pay for imports in currencies other than dollars. Foreigners could rid themselves of their holdings of U.S. financial assets, buying American real estate and merchandise.

The flight from the dollar could drives up interest rates and the shortage of imported goods could drive up prices, leading to rationing for the duration of the “war”, until America rebuilds factories in the “rust belt” and achieves a high degree of self-sufficiency that was the case one hundred years earlier. Meanwhile, the rest of the world might enter a prolonged period of economic and political crisis, forming antagonistic blocks reminiscent of the cold war. There would be no trade deficit, because there would be little trade.

The Euro Could Replace the Dollar: Leaders in France and Germany could make a political deal that would have Paris and Berlin alternate as the capital of a New European Political Union, with a common currency, the euro, backed by and freely convertible into gold at a fixed rate.

The European Central Bank could absorb all central banks of the former European countries. The European Parliament could adopt policies that would encourage other countries to become part of a European Trading Block and Expanded Euro Monetary Union, setting up national currency boards backed by euros.

European politicians could force the United States out of NATO, establish discriminatory tariffs against American goods, while forbidding that contracts be drawn up in dollars in the New European Political Union or its satellites. Through influence in the Mid-East, Europeans could convince Saudi Arabia, Kuwait, Iraq, and other oil producers to cause OPEC to shift from dollars to euro as the oil trading currency. The dollar deficit would disappear as international traders begin to favor the euro and refuse to sell in dollars.

Most important economic changes represent historical discontinuities for which we are totally unprepared. As long as the U.S. dollar remains the principal fiat currency in world trade, there is no reason for the trade deficit to stop growing.

Hundreds of millions of people throughout the world benefit from the current situation and have no objection to the U.S. trade deficit. The is no inherent instability presented by the U.S. trade deficit, in itself.

However, there is inherent instability in the process of globalization in a world stressed by terrorism and political tension. Today, the trade deficit works to the advantage of many people throughout the world, but this does not assure that things will not change tomorrow.