The other day I was perusing a Web site that listed historical
terrorist activity. Many people don't remember this, but in
the late '70s and early '80s the world was experiencing an average
of about 30 airplane hijackings every year; many of those occurred
right here in the United States. Terrorism is, in a sense, new in
how it's showing itself today, but it's not new in the sense that
it's affected our country before.
At the same time as those hijackings, the U.S. was under siege
from stagflation, double-digit inflation, and unemployment. The
French hated us. (They still do.) If you remember, Ronald Reagan
wanted to put Pershing II missiles in Germany and the French were
burning photographs of him and American flags in the streets.
In this respect, not much has really changed.
Conventional wisdom fretted about the budget deficit and
the trade deficit. We called them the twin deficits then. It's
not surprising, by the way, that we don't hear much talk about the
twin deficits today, because all of that analysis was really bad.
What you do hear frequently these days is that we're profligate
spenders, that our nation spends too much and runs a deficit.
That's true. Our government does spend too much. But as for claims
that our consumers aren't saving, this is patently not true. The
savings statistics these claims are based on are very
We are by far the wealthiest country on the face of the earth,
and the gains in that wealth and the amount of capital investment
Americans make indicate we are among the best savers in the world.
But the conventional wisdom is that our government doesn't
save, that our consumers don't save, and that therefore we have to
count on the largesse of foreigners to save for us. Specifically,
we have to count on China to buy our Treasury Bonds to finance our
war in Iraq or to keep our interest rates low so that the housing
market stays strong. This is nothing new--just a repeat of what we
heard 25 years ago updated for the modern era.
So I want to talk about this, because I think there's a lot of
very bad analysis about our trade deficit and the way our
international financial system really works. So, let's focus on
trade for a moment
What Happens to Trade Dollars?
Wal-Mart, for example, buys $20 billion to $25 billion worth of
goods from China every year. It buys those goods from thousands of
different companies that are producing little trinkets or T-shirts
or electronic equipment. Wal-Mart receives goods and our
dollars go to China. Now, China is in a unique situation
because at least until recently, there were very rigid controls on
who could hold dollars in China. If you were a manufacturer in
China and got dollars from Wal-Mart, you had to give those dollars
to the Central Bank in exchange for yuan. Today, it's
loosening up a little bit, but still it's not a free
Add OPEC into the equation. We buy oil in dollars. Dollars
go to OPEC. So now we have all these dollars in foreign hands. Many
people then turn around and say that foreigners lend us $2 billion
or more a day and if it weren't for this lending, our economy would
But I want you to stop and think before buying into this
argument. What choice does OPEC or China or any other entity
outside the U.S. have once they get dollars? They really only have
two choices. They either buy goods and services from the United
States or they buy dollar-denominated assets.
OK, there really is a third choice. Suppose you are OPEC and you
decide you don't like dollars and instead want euros. So you call
up your German bank and the banker tells you the exchange rate. In
an instant, with a few taps on a computer keyboard, the euros go to
OPEC and the dollars go to the German bank. But then the
German bank faces the same choice as OPEC. It has to buy goods and
services from the United States or make an investment. It's
much like the hot potato. Once the dollars are out of our country,
they must come back one way or another.
There is a possibility of a fourth choice. If someone
really doesn't want to make an investment in the United States,
doesn't want to encourage those profligate Americans, and they
really don't want to hold another currency, they can always convert
their trade surplus into cash, put those dollars on pallets, and
stick them in a warehouse. By the way, if someone actually chose to
do this ridiculous thing, the currency would be removed from
circulation and this would lead to a stronger dollar.
In the end, there are really only two paths for dollars to
take. They must be used to buy goods and services or to make a U.S.
Debits Also Mean Credits
Economists are too clever by half sometimes. There must be an
accountant or two in this room. You know a lot more about economics
than most economists do because you understand that for every debit
there must be a credit. The accounts must balance. So, when we have
a trade deficit, there must be a capital surplus, because those
dollars have to flow back into the United States. And so the
Chinese don't invest in the U.S. out of largesse or because they
want to be nice to us; they do it because they have no other
Now comes the fun part. People will ask: What if all these
foreigners decided to boycott and not make investments in the
United States anymore? Is that possible? What would they do? In
reality, they can't do anything. If they decided not to make
another investment in the U.S., they would be forced to spend those
dollars on our goods and services. And if they did that, our trade
deficit would disappear overnight. By the way, it would be
virtually impossible for this to happen. The U.S. does not
have the capacity to produce $700 billion worth of goods and
services and send them overseas in the next day or two. It can't
Taking all this into account, it appears that the world has
organized itself in the best way possible to lower the cost of
production and the cost of economic activity to benefit the
I was in Ireland about three and a half years ago. Hillary
Clinton's autobiography had just come out, and her book was in the
front window of every bookstore on the Island. I started thinking
about this. Here was an American author with an American
publisher. Do you think we printed those books here and shipped
them overseas? No. At best we exported a computer disk to the
printer (or a very large e-mail), and they printed the books, maybe
in continental Europe, maybe in the U.K., maybe in Ireland, and
then put them in the bookstores for sale. So, when you think about
the trade deficit in a global, knowledge-based, intellectual
economy, what does it in the end really mean? Apple makes about $40
from every iPod it sells. The manufacturer of the iPod--who
happens to be in China-- makes about $4 for every iPod that it
produces. Would you rather have the intellectual value or the
Now having said that, I want to tell you that the United States
in the past year has produced more goods than it has produced in
any 12-month period in its history. So, despite the trade deficit,
we are still the world's largest exporter and the world's largest
manufacturer. The facts do not support the rhetoric of the
doom-and-gloomers. The U.S. economy is simply amazing.
Thriving with a Strong Dollar
Now, let's talk about the dollar, which has been weak in recent
years. Many people argue that the dollar is falling because of this
massive trade deficit. I say--baloney!
The trade deficit has nothing to do with the value of the
dollar. What is the dollar, by the way? Why do we use it? The
answer: Because it's more efficient than bartering. I don't have to
carry around a side of beef on my back anymore. I don't have to
carry around a big heavy bag of gold. I can use currency. Most
money, in fact, never becomes currency and remains bytes in a
computer. We use the dollar because it's a more efficient commodity
to facilitate transactions than barter. The dollar is just a
commodity. And what determines the value of a commodity?
Supply and demand. That's all.
Who controls the supply of dollars? The Federal Reserve. It is
the only entity in the world that can control the supply of
dollars, putting aside the efforts of North Korean counterfeiters.
And so if perchance the demand for dollars falls, all the
Federal Reserve has to do is lower the supply of dollars. If
they do, the value of the dollar won't change.
If you look at the past six or seven years, the Fed was too
tight in 1999 and 2000 and the dollar soared. Then between 2001 and
2004 the Fed became accommodative--remember they drove interest
rates to 1 percent--and guess what? The value of the dollar fell.
When the Fed finally started to tighten in 2004, the dollar
strengthened. Now they've paused and guess what? The dollar is
weakening again. Why? In my opinion, because they paused too
early. They're not tight enough yet. In fact, we're facing some
inflationary pressures in the United States.
To bring this back to the beginning, the reason I'm talking
about the trade deficit is that there are many, many people trying
to use the trade deficit as a reason to support protectionism,
dollar devaluation, and tax hikes. This is exactly the same
policy prescription that the International Monetary Fund has taken
around the world for the past 40 years and they have ruined
hundreds of millions of people's lives with these
Any push toward a lower value of the dollar to boost exports or
tax hikes to limit demand for imports is harmful to the U.S.
economy. It would be the exact opposite set of policies that we
used in the early 1980s to end stagflation and economic
Faith in Free Markets
And so as we sit here today, I think we have a good fight in
front of us. The political scene has changed dramatically in the
past few weeks. Policies are beginning to shift and at the edges I
sense some buckling knees on all of these policy prescriptions.
But in the end, as we learned in the 1980s and 1990s, a tight
money, strong dollar policy, with low taxes and free markets is the
best way to create wealth.
When we get off into arguments about whether a trade deficit is
good or bad or whether the Chinese should or should not own this
many or that many hundreds of billions of dollars worth of bonds, I
always get worried because that's taking our eye off the ball.
What really separates a good economy from a bad economy is
faith--faith that by following the right set of policies, and
keeping the market free, you and I, the individuals in this
country, will do the right thing. And while we seem to be slipping
and sliding toward some bad policy decisions based on silly
arguments, in the end, the U.S. body politic has tended to do the
right thing. With the help of The Heritage Foundation, and others,
we should all keep the faith that we will continue to do the right
things. Have faith.
Brian S. Wesbury is Chief Economist
with First Trust Advisors L.P. in Lisle, Illinois. He made these
remarks at a meeting sponsored by The Heritage Foundation in
Chicago, Illinois, on December 4, 2006.