Sunday, April 8, 2018

Lee and Li Do a Deal

Let's say that Lee, an American, gets together with Li, a Chinese artist, via the internet and buys one of his paintings for $2,000. Li is happy to have 2,000 U.S. dollars, and Lee and his wife are thrilled with the beautiful piece of art now displayed above their mantel: A win/win by definition.

In my story, Lee happens to be a spender, while Li happens to be a saver; Lee likes nice artwork, Li likes to save and invest.

So, what will Li do with those 2,000 U.S. dollars, particularly if he's not in the mood to buy something made in the U.S. with them? 

Well, he'll be making an investment; maybe in a stock that trades on a U.S. exchange, or maybe a U.S. corporate bond, or maybe put it in a U.S bank, or maybe help the Federal government fund its deficit by buying a T-bill. Or if there's something in China, or somewhere else, he'd prefer to buy or invest in, he'll convert those dollars to the currency of his choice and make his purchase and/or investment elsewhere; which leaves those who handled the conversion to decide what in the U.S. they'll do with those 2,000 U.S. dollars. If there's a product (maybe some software, or some soybeans) or a service (we do lots of services) they're after, they'll spend some or all of it in that manner. Otherwise, they'll be investors in U.S. assets.

Now, for the sake of calculation, let's pretend that Lee and Li's transaction is the only business conducted by the U.S. at that particular moment. Here are the effects it will have on U.S. trade numbers:

1. If Li (or the converter of the dollars) invests all of the $2,000 in a U.S. stock, bond, CD or a T-bill, the U.S. will have a $2,000 goods trade (current account) deficit, and a $2,000 investment trade (capital account) surplus.

2. If Li (or the converter of the dollars) buys products from the U.S. for, say, $1,000 and invests the rest in a U.S. security, with the remaining $1,000, the U.S. will have a $1,000 goods deficit and a $1,000 investment surplus.

3. If Li (or the converter of the dollars) buys products from the U.S. for the full $2,000, the trade numbers will be in perfect balance; no deficit, no surplus.

Question: Is there a winner and/or a loser in any of my three examples? Of course not. In fact, it's impossible; trade, by definition, is a mutually beneficial act.

I wonder if maybe the chart below showing the hugely greater Chinese savings rate compared to America's doesn't go a long way toward explaining the persistent imbalance (more goods to us/more investments to them)?

Folks, all the tariffs in the world won't help the situation. In fact the situation doesn't need any help, it simply reflects the different stages of development among our two countries, and the habits of consumers. Protectionism can only slow the world's development and make us all poorer in the process...

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