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Trade deficits are not inherently bad.  In fact, they can be a good thing.  The idea that trade deficits are inherently bad seems to be the one thing that unites the political left and right.  Conservatives, being obsessed with money, tend to worry about money leaving our country and devaluation of the dollar.  Progressives on the other hand, tend to be more concerned with the internal unemployment that it causes.  The "jobs going oversees" phenomenon.  With such a left-right consensus, it's probably shocking to hear me say that trade deficits could be a benefit to the country.  If we better understood our monetary system, the wealth that they generate could be grown and be extended to benefit not just the wealthy, but everyone else-even those traditionally hurt by trade imbalances.

So how can we turn trade deficits into a good thing?  Well, trade deficits are inherently beneficial to a country.  Think of it this way.  When there is a trade imbalance, what is actually occurring is that country A is getting more stuff and country B is getting some of country A's money.  In terms of the United State, it means In exchange for dollars - which are either worthless pieces of paper or bits in a computer- they send us cars, clothes, furniture, and all other manner of things that make our lives better.  What a steal!  We should be celebrating trade deficits like our ancestors celebrated a bountiful harvest.  Why would we fear something that results in us getting more stuff?  Sure we have less money, but we don't want money, we want stuff!

The answer is of course that if the other country has some of our money, it means they can use that money to get more stuff from us the following year.  If left to themselves, this often manifests in the value of our currency going down vs. the currency of the other country.  That can lead to our imports becoming more expensive over time.  So how do we deal with the situation?

First of all, I'd like to squash the rumor that federal budget deficits are the cause of a trade deficit.  Prominent newspapers still wrongly imply that budget deficits cause trade deficits.  And their readers are equally misinformed.  Recent events have shown this assumption to be wrong. In 2008-2009 the budget deficit grew, but our trade deficits shrank.  Back in the 80s, the opposite happened.  This shows strong evidence that there is no useful correlation between the two.  Further, the whole theory was mostly based on economists who like math to the detriment of common sense.  They started with the standard GDP equation: Y = C + I + G + NX which is
GDP = Consumption + Investment + Government Spending + Net Exports(or Exports - imports).  The economist "assumed" GDP was constant, and therefore if G increased, then one of the other 3 variables, like Net Exports, had to decrease to make the equation balance.  Thus was born the meme that budget deficits cause trade deficits.  From a math perspective it's sound, from an economics perspective, it's a lot of assumptions.  The biggest being that GDP would remain constant.  It never occurred to them that if you increase G, that Y would increase.

What's fascinating about this is that in reality, we know what causes trade deficits.  They occur when it's much cheaper for a company to make a product in another country and ship it to the United States than it is to produce it domestically.  Common sense would dictate that no matter how much or how little the federal government spends, it's not going to change that fact.  If it's cheaper to produce a T-shirt in Mexico, that fact is not going to change if the government spends 5 dollars or 5 trillion dollars.

So what's a good way to deal with the situation?  Before proposing something.  Let's take a look at how we currently deal with the situation.  Since our leaders, especially conservatives, who are obsessed with money, they take a look at the problem and say, "hey, the value of our currency is going down.  We must do something about that."  Therefore, they restrict government spending, raise interest rates, and cause massive unemployment so that the value of our currency can be maintained.  If the problem was solely a monetary issue, that might make sense.  However, the value of currency on the foreign market going down isn't the root of the problem:  it's the trade deficit. It's cheaper to produce a T-shirt in Mexico and Pakistan and that's where the job goes.

The solution progressives typically propose is better.  We typically propose trade barriers for better labor laws and environmental regulation, or even outright tariffs.  I like this solution because it shows that progressives understand the actual disease and aren't just treating the symptoms.  I would however, like to propose an even better approach.

Let Free Trade stay.  Instead, lets take advantage of the free goods.  While Pakistan is making our shirts, China making our ovens, and Mexico is making our cars, let's take advantage of our time and do something useful:  Go to college, build better/faster trains, research new technology.  We do this to build a more productive workforce.  That way, when it's time to reverse the trade deficit, we can afford to produce those products to get our money back without suffering a loss in our quality of life.

Right now, we aren't taking advantage of our free products.  The jobs are being sent overseas, and, instead of finding a new job for our workers, we're letting them stay idle in the unemployment lines.  We are doing the WORST thing we could possibly do.  We're letting our dollars be accumulated overseas, AND we're letting our workforce and infrastructure decay here at home.  Sure the restrictive fiscal and monetary policies will temporarily keep our currency valuable, but it won't last forever.

Of course, to do all that I propose, would require federal spending - deficit spending no less.  But as I've said before, the federal budget is constrained by inflation, not revenue. One might think that this could cause inflation.  As long as there are so much unemployment and other idle resources, demand-pull inflation won't be a problem.

You may think that this sounds familiar.  The whole free trade-globalization schtick that Thomas Friedman has been trying to peddle.  The idea that our newly unemployed manufacture workers can go to school and become engineers and we'll all benefit.  That proposal and this one differ in two key ways because proposal rejects the free market fundamentalism that Thomas Friedman peddles.  The first way is that in this proposal, we don't have to send everyone back to school to become productive.  There's still room in construction or other jobs.  Federal spending can target infrastructure or other tradistional projects.  The other, and even more critical difference is the concept of a budget deficit.

For us to keep our workers employed at the same time we're holding a trade deficit, one of two things has to happen.  Either all our citizens and companies have to sink further into debt, or our government must sink into debt.  Don't believe me?  Let's bring back the standard GDP formula that economists use.  Y = C + I + G + NX
Y is our total GDP or production of goods.  If NX goes down(that is money leaves the economy to foreign entities) either Y is going to go down with it(causing unemployment), OR one of the other 3 variables has to increase.  Either the consumers(C), business(I), or government(G) has to increase spending to keep the GDP level.  Well, with more money being shipped overseas than coming in, the only way 1 of those groups can spend more money is to "borrow" it and go into debt.

In the 90s and early 00s we saw that to maintain the trade deficit, consumers increased their debt to record levels.  Now, consumers are cutting back and the government is now carrying the debt via budget deficits.

When dollars flow overseas we have two options:  Let the newly unemployed workers sit idle, or have the federal government deficit spend to make the newly unemployed productive.  Which would you rather do?

Much of this analysis is based on Modern Monetary Theory or MMT for short.  It's a (relatively) new "Post-Keynesian" economic school of though.  If you're interested in learning more, please follow our group, Money and Public Purpose.  Also, there is a small, but growing MMT wiki that is worth checking out.

Originally posted to Money and Public Purpose on Tue May 17, 2011 at 06:30 AM PDT.

Also republished by A Perfect Conversation.

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