Milton Friedman, the Nobel Prize-winning economist and father of Monetarism, argued that many of the fears of trade deficits are unfair criticisms in an attempt to push macroeconomic policies favorable to exporting[13] industries. He stated his belief that these deficits are not harmful to the country as the currency always comes back to the country of origin in some form or another (country A sells to country B, country B sells to country C who buys from country A, but the trade deficit only includes A and B). In fact, in his view, the "worst case scenario" of the currency never returning to the country of origin was actually the best possible outcome: the country actually purchased its goods by exchanging them for pieces of cheaply-made paper. As Friedman put it, this would be the same result as if the exporting country burned the dollars it earned, never returning it to market circulation.
Friedman also believed that deficits would be corrected by free markets as floating currency rates rise or fall with time to encourage or discourage imports in favor of the exports, reversing again in favor of imports as the currency gains strength. A potential difficulty however is that currency markets in the real world are far from completely free, with government and central banks being major players, and this is unlikely to change within the foreseeable future. Nevertheless, recent developments have shown that the global economy is undergoing a fundamental shift. For many years the U.S. has borrowed and bought while in general, the rest of the world has lent and sold. However, as Friedman predicted, this paradigm appears to be changing.
As of October 2007, the U.S. dollar has grown weaker against the euro, British pound, and many other currencies. For instance, the euro hit $1.42 in October 2007[14], the strongest it has been since its birth in 1999. Against this backdrop, American exporters are finding quite favorable overseas markets for their products and U.S. consumers are responding to their general housing slowdown by slowing their spending. Furthermore, China, the Middle East, central Europe and Africa are absorbing more of the world's imports which in the end may result in a world economy that is more evenly balanced. All of this could well add up to a major readjustment of the U.S. trade deficit, which as a percentage of GDP, began in 1991.[15]
Friedman and other economists have also pointed out that a large trade deficit (importation of goods) signals that the country's currency is strong and desirable. To Friedman, a trade deficit simply meant that consumers had opportunity to purchase and enjoy more goods at lower prices; conversely, a trade surplus implied that a country was exporting goods its own citizens did not get to consume or enjoy, while paying high prices for the goods they actually received. In view of the fact that countries with a highly positive trade balance (such as Germany or Japan) offer their citizens the same or more goods and services as do countries with a negative trade balance (such as the United States or the United Kingdom), this hypothesis must certainly be regarded as falsified.
Perhaps most significantly, Friedman contended strongly that the current structure of the balance of payments is misleading. In an interview with Charlie Rose, he stated that "on the books" the US is a net borrower of funds, using those funds to pay for goods and services. He pointed to the income receipts and payments showing that the US pays almost the same amount as it receives: thus, U.S. citizens are paying lower prices than foreigners for capital assets to exchange roughly the same amount of income. The reasons why the U.S. (and UK) appear to earn a higher rate of return on their foreign assets than they pay on their foreign liabilities are not clearly understood. An important contributing factor is that the U.S. has investment primarily in stocks abroad, while foreigners have invested heavily in debt instruments, such as U.S. government bonds [16]. [17] Other reports contend that U.S. net foreign income has deteriorated, and appears set to stay in deficit in the future [18].
Friedman presented his analysis of the balance of trade in Free to Choose, widely considered his most significant popular work.
Physical balance of trade
Monetary balance of trade is different from physical balance of trade (which is expressed in amount of raw materials). Developed countries usually import a lot of primary raw materials from developing countries at low prices. Often, these materials are then converted into finished products, and a significant amount of value is added. Although for instance the EU (as well as many other developed countries) has a balanced monetary balance of trade, its physical trade balance (especially with developing countries) is negative, meaning that in terms of materials a lot more is imported than exported.
United States trade deficit
The United States has posted a trade deficit since the 1970s (since the US came off the so-called gold standard in 1971), and it has been rapidly increasing since 1997[19] (See chart). The US trade deficit hit a record high of 817.3 billion dollars in 2006, up from 767.5 billion dollars in 2005.[20] This sizable trade deficit has only been possible for the US because of the use of the US dollar as an international reserve currency. This means that as long as there is a demand for dollars overseas the Federal Reserve can just print more dollars "out of thin air" without any negative consequence related to exchange rate as long as it is done in a continuous, anticipated way as has been the case since the 1970's.
It is worth noting on the graph that the deficit slackened during recessions and grew during periods of expansion. Also of note, many economists calculate trade deficits and/or current account deficits as a percentage of GDP. The US last had a trade surplus in 1991, a recession year. Every year there has been a major reduction in economic growth, it is followed by a reduction in the US trade deficit.[15] The well known investor Warren Buffett has proposed a tool called Import Certificates as a solution to the United States' problem.[21]
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