[Jthomp76]

Why are` our national debt and our trade deficit shrinking? I believe our economy is heading in the wrong direction but these stats conflict w that idea.

[jmherbener]

The national debt is still growing.

http://research.stlouisfed.org/fred2/series/GFDEBTN?cid=5

Here is the federal budget:

http://www.whitehouse.gov/sites/default/files/omb/budget/fy2014/assets/tables.pdf

The federal deficit has been falling and is projected to fall further (table S-1).

But the burden of the government on the economy is its expenditures, which continue to rise (table S-5). The size of the deficit is a secondary matter. It’s being reduced by raising taxes. If it were being reduced by cutting expenditures, then it would be significantly beneficial for the economy.

The merchandize trade deficit has nothing to do with the health of the economy. It merely reflects the different preferences people around the world have for goods, services, capital investments, and money holdings. When taking all factors into account, the balance of payments accounts always balance.

http://www.bea.gov/international/

Click on “”U.S. International Transactions, 1960-Present” under “Balance of Payments (International Transactions)” to see the data.

[Jthomp76]

In regards to trade deficit, how does the deficit not reflect a struggling economy? If we were producing a lot of goods would we not be more competitive? Were we not once a net exporter? Doesn’t the deficit show we are a nation of consumers, not producers?

[jmherbener]

In a division of labor each person produces to satisfy the consumptive ends of other people and has his consumptive ends met by them. Naturally, each person will run trade deficits with every person from which he buys their outputs and trade surpluses with every person to which he sells his outputs.

A person’s overall trade balance with all other people could be either in deficit, surplus or balance. If it is in deficit, it means that he has traded capital funding to others in exchange for their output. If it is in surplus, it means that he has traded his output to others in exchange for their capital funding.

A trade deficit, then, doesn’t reflect an unproductive or uncompetitive person. It indicates that he prefers to obtain goods from others by paying them in goods and capital funding and others prefer to receive his goods and capital funding in payment for their goods.

There’s no correlation between trade deficits and the performance of the economy.

From 1790-1860, America ran trade deficits almost every year.

http://www.nber.org/chapters/c2491.pdf (Scroll down to Tables 1 and 3)

After 1865-1900, America ran trade surpluses almost every year.

http://www.nber.org/chapters/c2491.pdf (Scroll down to Table 27)

[Jthomp76]

Gotcha. I keep hearing via Peter Schiff and others that we are not manufacturing enough. I imagine this is largely because we have no savings, no capital investment, etc? How does this lack of manufacturing show up in our economy if not in the trade deficit?

[jmherbener]

Employment in manufacturing has fallen from just under 15 million in 2003 to just under 12 million today. Peak employment was in 1979 at 19.5 million.

http://data.bls.gov/timeseries/CES3000000001?data_tool=XGtable

Here’s a congressional study on U.S. manufacturing. No surprise, we’re still the biggest manufacturing country in the world. Although, U.S. share of world manufacturing has been falling.

http://www.fas.org/sgp/crs/misc/R42135.pdf

The trade statistics don’t break down the types of merchandise traded in the balance of payments, i.e., whether manufacturing, mining, agriculture, and so on. The basic categories are merchandise and services.

The shift away from manufacturing toward other sectors is likely a natural result of adaptation to our changing comparative advantage in the world. China has developed a large manufacturing sector because its more efficient to have them do this instead of us and its more efficient for us to do other things. People in both places gain. Employment in manufacturing would fall and its contribution to our overall production would shrink, but standards of living rise.

America went through a similar shift concerning agriculture last century. But hardly anyone today thinks it’s a bad thing for American society that only 2 percent of our workforce is in agriculture instead of 20 percent or 40 percent.

[Jthomp76]

Great point. Am I wrong though that we have become a nation of borrowers and spenders, and not savers? It seems our government as well as individuals are living on credit not savings. What are some visible signs of this behavior if not the trade deficit?

Also, how much of China’s dominance in manufacturing is due to their efficiency as you say and how much is due to the fact that they peg their currency to the dollar so our dollars buy more of their stuff?

[jmherbener]

Yes, Americans have higher time preferences today than Americans a hundred years ago. Evidence of this is saving as a proportion of income. In the late 19th century Americans saved 20-25 percent of their income. Today it’s 5 percent. Other evidence would be personal debt per household. Their was almost no consumer debt in America before the 1920s. Now the personal debt per household is around $200,000. Of course, it’s also true that the average household hold much more valuable assets than it did a hundred years ago.

Here’s a Fed study on household debt:

http://www.newyorkfed.org/research/national_economy/householdcredit/DistrictReport_Q12013.pdf

[Jthomp76]

Is this a sign of an unhealthy economy?

[jmherbener]

A healthy economy is one that satisfies our preferences. If we have higher time preferences, then we want the economy to growth less rapidly so that we can devote more resources to producing consumer goods now instead of building up a bigger capital structure to produce more consumer goods in the future.

One might claim that it’s better for people to have lower time preferences instead of higher, but economic theory makes no judgment about what people’s preferences are. Economic theory explains which means are suitable to attain the ends people prefer and which are unsuitable.

[Jthomp76]

So a man who lives on credit cards and runs up massive debt is just as well off as a man who is thrifty and saves? I remember Hazlitt’s story of two brothers. The brother who spent all his money didn’t end up so well.

[jmherbener]

No, a person with high time preference will not live as well as a person with low time preference. But you were asking about the performance of the economy not about a person’s life. The economy’s performance is judged by how well we satisfy our preference in arranging a division of labor in production. Whether we have high time preferences or low time preferences, the market’s performance is judged by how well the market satisfies those preferences. Faster growth rates of GDP do not indicate a better performing economy than slower growth rates of GDP. If people have high time preferences, then slower growth rates of GDP indicate a well performing economy and if people have low time preferences, then faster growth rates of GDP indicate a well performing economy. But if people have high time preference, a faster growth rate of GDP does not indicate a better performing economy. It more than likely indicates that the Fed has generate a boom.

[Jthomp76]

So you’re saying if we as an economy prefer to consume and run up debt it is healthy so long as that is what we prefer?

[jmherbener]

If some people have higher time preferences and others lower time preferences and they are willing to engage in mutually advantageous lending and borrowing, the the market is “healthy” if the trades are made and “unhealthy” if the government prevents the trades from being made. Whether or not those with higher time preferences are wise to take on the debt is not a question that can be answered by economics reasoning alone.

At best, economics can explain the distinction between sustainable indebtedness and unsustainable indebtedness. In the unhampered market, the lenders will assess the likelihood of the borrowers to pay back their loans. They will lose if they overestimate the willingness and ability of the borrowers to pay back and they will gain if they accurately estimate. Thus, indebtedness is regulated in the market by the same profits and losses that regulate the production and exchange of anything. As I cited in a previous post, the average American household is much more indebted today than a hundred years ago. But, the bulk of that debt is sustainable because the average American household hold more assets. There is nothing unsustainable about a young person borrowing to buy a house and using his future earnings to pay for it.

Unsustainable indebtedness comes about when the Federal Reserve engages in monetary inflation and credit expansion. Some of the creation of credit is extended to borrowers who have neither the willingness nor the ability to pay back their loans. Banks are willing to do this because Fannie Mae and Freddie Mac created massive secondary markets for these sub-prime mortgages. The banks would earn the fees to write mortgages they knew would not be paid back and then sell them to Fannie and Freddie. The Fed is the source of unsustainable indebtedness in our economy, both private and governmental.

[Jthomp76]

Great stuff, thank you! In regards to your above response about time preference, do artificially low interest rates in essense “trick” us into altering our spending and borrowing habits? In other words you say we have fewer savings because we now have higher time preference but is it possible that this isn’t totally the case and we are actually induced into more consumption because of the low rates and disincentive to save?

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