by Jurgen Brauer, December 2003
Copyright: J. Brauer. No reproduction without permission.

The mysteries of the international trade and financial markets include something called the balance of trade and the balance of payments. You are probably aware that the United States exports fewer goods and services than it imports. For every Boeing aircraft we export, we import millions of Chinese-made toys. For every Hollywood movie we export, we import millions of shirts made in Indonesia. And for every piece of Microsoft software that is exported, we import tens of thousands of Canadian timber logs.

There are a number of interesting things to say about international trade. One of those includes tracking the financial flows associated with international trade. When Boeing exports a newly produced 777-aircraft to Malaysia, the country has to pay Boeing in US dollars (so the company can pay its suppliers and workers in dollars). The funds flow through the international financial network, and the United States government enters the dollar value of the transaction in the so-called US balance of payments as a credit item, just as you enter the dollar value of your paycheck as a credit or +-item in your checkbook. The $100 million dollars Boeing earns on selling the 777-aircraft to Malaysia represents an inflow of dollars into the US.

Now, where in the world did Malaysia get the dollars from to pay for the aircraft? The simplest way to answer that question is to observe that US companies and consumers not only sell stuff to Malaysia but also buy from it. For example, we buy computer components and apparel from Malaysia. For every item we purchase we pay in US dollars, and these are treated as debit or minus-items in the US balance of payments, exactly like writing a check to purchase groceries is treated as a debit item in your checkbook. In a word, the trading part of the US balance of payments is nothing more (and nothing less) than a gigantic national checkbook. When we sell something to others, money flows in: it is credited to the account. Conversely, when we buy something from others, money flows out: it is debited to the account.

The trade balance is nothing but a gigantic national checkbook - and sometimes we live beyond our means.

As many a reader knows too well, credits and debits do not always equal each other. For many, the money flowing out exceeds the money coming in. There is a trade deficit. You trade your ability to work for which you receive payment (a credit). Then you trade your earnings for food, clothing, car payments, and entertainment (all debits). At the end of the month you discover that you lived beyond your means (a trade deficit).

Exactly the same happens with regard to the trading part of the US balance of payments. When we import (debits) more than we export (credits), a trade deficit results. This means that we gave more dollars to foreigners (to buy their goods) than they gave back to us (to buy our goods). Consequently, foreigners literally are sitting on a pile of US dollars. It runs into the hundreds of billions of dollars each year.

What can foreigners do with US dollars? They can wallpaper their homes with greenbacks but that would seem extravagant. The only reasonable thing to do is to take those dollars and invest them into the US financial markets, e.g., to buy stocks and bonds. Alternatively, foreigners can sell their US dollars either to other foreigners or they can sell their dollars to their own country's central bank. In either case, however, so long as the dollars stay abroad they are worthless. Eventually, the dollars will be invested back in the US economy via the financial markets, and the balance of payments will, indeed, be in balance.

This sounds like a dream. We purchase Chinese-made toys for Christmas, purchase Canadian timber, purchase Indonesian shirts and Malaysian computer components and send dollars abroad that then have to come back to prop up our financial markets. In essence, we get the goods and we get the dollars right back.

Surely, there must be a downside to this dreamland. If the world reflected economic theory perfectly, the excess supply of dollars would eventually diminish its value. It would be able to purchase less abroad. Our expenditure on foreign goods would fall, the debits in the balance of payments would diminish, and the system would gradually right itself. In practice, however, foreigners are generally quite happy to invest the dollars they earn by selling us things back into the US because more often than not they view our economy and the political system upon which it is based with more confidence than they view their own economy and polity. This fortuitous set of circumstances allows the US to continuously live beyond its means, importing more than we export. Other countries' currency values would have long since crashed and forced the correction.

A currency crash means that your earned income buys fewer goods. You work the same hours, but can buy only half as much as you used to. There is no telling whether we might not yet share such fate ourselves one day. It would be a major catastrophe.