The Paradox of International Trade Deficits

Many people still have the idea that a trade deficit is an unqualified negative, but since we went off the gold standard, that unqualified judgment no longer really applies.

Back in the days of the gold standard, an imbalance of trade would be settled in gold. So, a country operating a trade deficit would be chronically bleeding gold. In fact, that exact thing was happening to America in the early 1970s, leading Nixon to take the dollar off of its international gold standard .

The situation today is much different. The deficit country gives slips of paper to the surpluss country, in return for real goods. Who is really getting rich in that scenario? Obviously, its better to get stuff and give paper. The surplus trade partner is just plain dumb in the first place for accepting a non-objective currency as a settlement of account.

They are even dumber for then reinvesting those dollars in dollar-denominated debt. Seriously, would you give a loan to someone expecting repayment in a paper currency they can print out at will? It is asking to be taken advantage of, quite frankly.

The only rational thing to do with a paper currency from a foreign issuer is to immediately plow it back into real goods and services.

This analysis merely highlights how irrational Chinese economic policy has been. Actually, to be clear, it is only irrational from the perspective of maximizing value. It is not irrational, it makes perfect sense actually, in light of their true policy objective: full employment. The Chinese are willing to sacrifice a great deal to maintain full employment.

The problem for us is that by hitching our economies together, our economy is distorted by their irrational economic objectives. We get tons of cheap Chinese junk and a bloated financial sector, but lose real productive jobs.

Worst of all, we are subsidizing the unsustainable, inefficient, and destructive production goals of the Chinese government. In classical economic terms, this is called malinvestment.

It makes no economic sense to keep people employed by making half of them construct houses and the other half tear them down. But under a command economy, such economically destructive processes go on all the time. In fact, the Chinese already have a large overcapacity of housing supply, but that doesn't stop them from building more under the direction of central planners.

In the Soviet days, their planned economy was isolated, firewalled off from the free world. Today, ours is linked to theirs. On the one hand, we benefit from all the cheap goods they give to us for paper dollars, on the other hand, we suffer from inflated commodity prices and the loss of jobs, and we encourage an unsustainable and destructive economic system.