A Deficit of Understanding

As readers of my regular blog Cafe Hayek know, I’m obsessed — perhaps even too obsessed — with straightening-out the widespread and deep misunderstanding of the so-called “trade deficit.” One blog-post is no place to review this misunderstanding, much less to correct it. (I recommend this essay as a place to begin if you’re interested in learning the rudiments of this concept.)

But let’s review just one simple point: if the U.S. trade deficit (more properly called the “current-account deficit”) increases, this fact means that foreigners are investing relatively more in the United States — investing more in dollar-denominated assets — than Americans are investing in foreign assets.

Here’s a letter that I sent today to the Wall Street Journal, exposing (or so I fancy) an especially egregious instance of this misunderstanding:

25 May 2006

Editor, The Wall Street Journal
200 Liberty Street
New York, NY 10281

Dear Editor:

AFL-CIO Secretary-Treasurer Richard Trumka says that an undervalued yuan increases both America’s current-account deficit with China AND “the flood of investments by U.S and other multinational companies” into China (Letters, May 25).

This allegation reveals Mr. Trumka’s colossal misunderstanding of international-trade concepts. America’s current-account deficit with China grows as the volume of Chinese investments in America increases relative to the volume of American investments in China. How can the price of the yuan (or anything else!) cause Americans to invest less in China and more in China simultaneously?

Donald J. Boudreaux
Chairman, Department of Economics
George Mason University

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