Don't Worry About the Trade Deficit
Jude Wanniski
June 12, 2000


To: Rick Stevenson, NYTimes
From: Jude Wanniski
Re: Your Saturday Piece

[Regular fans of our website will note that several times a year I will send a “Memo on the Margin” to Richard W. Stevenson of the NYTimes. The reason is that he is the most important of the several Timesmen who cover political economics, working out of the Washington bureau. He is definitely a cut above most such correspondents. I try to read everything he produces because he talks to a wide range of people and gets close to the margin in what he does. My memos to him are frequently complimentary, although this one is sharply critical. It is a memo I actually sent to him by E-mail on Saturday after reading his featured report on the first page of the Times “Business Day.” He asks the question, What can disturb the economic expansion underway without interruption during the past decade and focuses on the trade deficit that has accompanied that expansion. I was not terribly happy with the result, as you can see.]

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Yes, there is good reason to examine the trade deficit as a possible source of difficulty for the economy, if only because so many people are worrying about it publicly. I'm not worried about it, though, because of the circumstances in which it has arisen. Your piece could have been far better and complete if you had gone beyond the Keynesian model and people like Fred Bergsten, who has given many thousands of speeches in the last 30 years on how our trade deficit will disappear if we devalue the dollar. It never happens, so he says we should devalue more. His model has never changed but for some reason Times reporters rely upon him as if he were a visionary. The Times being the Times, the rest of the news media dutifully follow.

In the classical model, Rick, the exchange rate has nothing to do with the trade accounts. Nothing. Classical theory had evolved over centuries to the conclusion that you cannot change the terms of trade by changing the unit of account -- which was the mercantilist model of the 18th century. I remember Art Laffer more than 25 years ago doing a study of something like 101 devaluations and finding the trade balance got higher in 51 cases and lower in 50 cases. Bergsten and Co. howled and said it was well known that Laffer did sloppy research work. Bergsten and Co., though, did not attempt a correlation because it would have destroyed the foundations of their trade model. I've discussed this with a long string of NYT reporters, but none seem to care. So we wind up seeing Bergsten's picture again and again on page one of the business page...and the developing world gets poorer and poorer.

In a classical, supply model, a nation's trade deficit is only worrisome if it results from its government borrowing abroad to finance public-sector projects, which more often than not will fail to produce sufficient returns to pay the interest on the nation's external debt. This is the IMF/World Bank trap. The nation must then raise taxes on its people to pay the debts arising from socialist investments.

There is no worry at all with the current U.S. trade deficit because it results from private citizens absorbing capital from abroad in exchange for private debt or private equity. If the private project fails to produce a positive ROI, the domestic and foreign investors must absorb the loss. The government need not raise taxes on its people. The market sorts out the losses.

We have been writing about this for almost 30 years, Rick, but the NYT reporters and editorialists, with the occasional exception, insist on covering the issue from Bergsten's obsolete analytical framework. If you want to know why there is so much poverty in the world, therein lies part of the answer. I expect reporters with Ph.D.s in economics to make this mistake, because they are taught only the demand model. But you don't have that burden and are limited only by the names of the people in your Rolodex. The reason I have been one of a few lonesome voices denouncing the policies of the IMF for the last quarter century is because I realized it is trapped in a mercantilist model, which makes the economies that must submit to its dictates always weaker, never attractive to capital inflows. We suck the lifeblood out of their economies and it shows up as a trade deficit on our books. The answer is not to weaken our economy faster than they weaken theirs, but to encourage them to adopt the kind of classical fiscal and monetary policies we followed when we were an up-and-coming developing nation.