Thursday, October 28, 2010

For the year 2007, we had a current account deficit or "trade deficit" of about $700 billion, and a capital account surplus, or capital inflow of approximately the same amount, of about $700 billion (statistical discrepancies account each year for any differences). Americans in 2007 purchased $2.35 trillion of goods and services from foreigners, which was more than the $1.65 trillion foreigners spent on U.S. goods and services in that year. On the other hand, foreigners invested more than $2 trillion in U.S. assets in 2007 (stocks, bonds, real estate, Treasuries, direct investment), which was more than the approximately $1.4 trillion invested by Americans overseas in foreign assets, resulting in a net capital inflow of about $700 billion into the U.S. that year.

In other words, the $700 billion "trade deficit" in 2007 was exactly offset by a $700 billion capital account surplus, or capital inflow, and the overall BOP = -$700 billion + $700 billion = 0. What are the lessons from this?

1. There are no BOP deficits once we account for all international transactions, both for: a) goods and services, and b) financial transactions. For all of the one-sided coverage in the press about the "trade deficit," you would almost never even know that there is an offsetting "capital surplus" or "capital inflow." It's important for the general public to understand that trade deficits are offset by capital inflows on almost a 1:1 basis, resulting in a "balance of payments" for international transactions. When the public constantly hears about "trade deficits" without any understanding of the offsetting surplus, that economic ignorance allows politicians and special interest groups to exploit the general public, by advancing and promoting protectionist trade policies aimed to reduce the "trade deficit," or by refusing to approve trade agreements between Colombia, Panama and Korea, etc.

2. The "trade deficit" generates so much negative coverage, that the significant advantages of capital inflows from abroad get frequently overlooked. Since 1980, the U.S. has attracted almost $8 trillion of foreign investment, which has provided much-needed equity capital that has allowed U.S. companies to start or expand, has provided much-needed debt capital that has also funded the expansion of American companies, along with providing debt capital for U.S. consumers in the form of mortgages, student loans, and car loans. Some of the $8 trillion of investment includes billions of dollars of Foreign Direct Investment, which has funded thousands of new projects in the U.S. (Toyota factories for example) and created hundreds of thousands of jobs.


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