No Free Lunch: Economics for a Fallen World: Third Edition, Revised

Chapter Fifteen: Issues in International Economics 373 season and to bless all the work of your hand; and you shall lend to many nations, but you shall not borrow ” (emphasis added). Conversely, if Israel rebelled against God the opposite would be true—Israel would be dependent upon foreigners. 43 The alien who is among you shall rise above you higher and higher, but you will go down lower and lower. 44 He shall lend to you, but you will not lend to him; he shall be the head, and you will be the tail. 45 So all these curses shall come on you and pursue you and overtake you until you are destroyed, because you would not obey the LORD your God by keeping His commandments and His statutes which He commanded you. 46 They shall become a sign and a wonder on you and your descendants forever. We don’t want to carry this too far—commands for ancient Israel are not necessarily commands for the U.S. today—but to the extent that we go one way or the other, it seems we should want to be the country that has extra resources to lend rather than being the one dependent upon borrowing; we’d rather be the head than the tail. Third and finally, a preference for lower debt (or less foreign claims on our future consumption) is also borne out in learning the lessons of economic history. Countries with trade deficits exceeding 5% of GDP tend to suffer crises of confidence in markets. Investors begin to lose confidence that the money they will receive in the future will be worth it. They begin to fear the historically normal occurrence of default and currency debauchery. So capital sprouts wings and takes flight—usually resulting in a severe recession. The Asian financial crisis of the late 1990s and the Greek crisis of 2010-2011 are examples of this. You may likewise look at government debt as the causal factor; but trade deficits greater than 5% reduce a country’s ability to pay off its debts. If a country had a large foreign debt but large trade surpluses, it would be much easier to pay off the debt. Debt and trade imbalances often go hand in hand. If a country uses currency debauchery (inflation) to reduce its debt, the inflation affects not only foreign holders of U.S. debt by reducing their real rate of return, but it raises the cost of living for all Americans. What can we conclude? Trade deficits are not necessarily a problem, per se, if they are matched by real foreign investment in our capital account in productive enterprises, rather than to fund additional current consumption. The nature of the capital account surplus is thus the more important issue. If the trade deficit supports government consumption, we will have to reduce consumption in the future to pay it back. If it supports private investment (and to the extent that the investments pay off), foreigners will have an ownership stake in assets in America that can support their desired future consumption, with no loss in consumption by Americans.