By: Tim Hayes Financial Advisor - posted in: Economy, Markets, and Interest Rates - Last updated May 19, 2019

President Trump’s Risky Bet Against Trade

by | Economy, Markets, and Interest Rates

A consensus converged in the 1980s around three economic principles:

  1. reduced regulation of banks;
  2. free trade;
  3. liberalizing immigration.

Today, many people in Europe, Great Britain, and the U.S. are questioning nos. 2 and 3—particularly President Trump, and his top economic adviser Peter Navarro, who are questioning the benefits of trade, especially when that trade causes the U.S. to have a trade deficit with another country.

Trade deficits reduce economic growth, according to a theory posited by the great 18th-century Scottish economist and philosopher David Hume: the outflow of gold to pay the shortfall (trade deficit) would contract the money supply and automatically lead to the reduction of domestic prices, as if by an “invisible hand.”[i]

What is a Trade Deficit?

A trade deficit occurs when we buy more goods and services from a country than we sell to it. Hume worried that such a shortfall could deplete a country of its reservoir of gold, as the nation that sold those goods could request payment in gold.[ii] Moreover, since, in theory, the amount of gold determined how much banks could lend, any depletion of that supply would have an enormous financial effect on a country that expends more than it receives.

Today, however, no country is on the gold standard, and almost all banking systems are closed, which means their money must remain in their banking systems. Therefore, Mexico, like any other country that sells goods here in the U.S., must use any proceeds to buy U.S. financial assets or our goods and services. To “bring money home,” Mexico must first go to the currency market and sell its dollars to receive pesos.

Who Buys Currencies?

Commercial banks, central banks, speculators, hedge funds, funds, and companies that want to hedge their currency risk all participate in this enormous foreign exchange market, in which average daily trading volumes are approaching $5.3 trillion.[iii] In contrast, the average trading volume in 2013 for stocks on the NYSE was $169 billion.

What Happens When U.S. Companies Sell Overseas

Foreign sales by U.S. companies trap money in the banking system of other countries. Germans buy Apple computers or iPhones with euros. Japanese pay with yen. This means, if Apple or some other U.S. based company wants to “bring that money home,” it must also go to the currency market and sell its yen or euros.

Moreover, “bringing money home” does not change the number of dollars available for our economy, which gives us no additional purchasing power. All that changes is who owns the dollars, which makes suspect all of these claims that we need to lower the tax rate to incentivize companies to repatriate the $2.4 trillion they have trapped in banks overseas.

These companies knew the rules when they sold products overseas. So why should we reconfigure the tax code again, when most of the returning money will go to executives and shareholders and simply increase our income inequality?

Why Every Country Can’t Export More

Are We Addressing the Wrong Problem?

Capitalism has a propensity for credit bubbles, because, as the great English economist John Maynard Keynes pointed out in his classic Treatise on Money, “It is evident that there is no limit to the amount of bank money which banks can safely create provided that they move forward in step.”[iv]

However, what capitalism does better than any other economic system is what the great economist Joseph Schumpeter called “creative destruction,” or innovation fueled by competition.[v] Thus, anything that reduces competition, such as trade barriers, has the potential to extinguish the fire that fuels capitalism, while any relaxing of bank lending regulations has the potential to burn the system down.

[i]  Ingham, Geoffrey. The Nature of Money. Cambridge, U.K., and Malden, Mass.: Polity Press, 2004.

[ii]  Hume, David. Essays Moral, Political, and Literary. Indianapolis: Liberty Classics, 1987.

[iii]  McLeod, Gregory, and Simone Foxman. “Forex Market Size: A Traders Advantage.” DailyFx, January 23, 2014. https://www.dailyfx.com/forex/education/trading_tips/daily_trading_lesson/2014/01/24/FX_Market_Size.html

[iv]  Ingham, op. cit.

[v]  Schumpeter, Joseph. Capitalism, Socialism and Democracy (New York: Harper & Row, 1942), p. 83.

These are the opinions of Financial Advisor Tim Hayes and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice.

 

Please Share

About Financial Advisor Tim Hayes

No cookie-cutter solutions

As an independent financial advisor, I have access to many financial products, including mutual funds, ETFs, stocks, bonds, annuities, and life insurance programs. I use these and other products to build custom solutions for people, according to their individual needs and goals

Click to Call

Subscribe to Blog via Email

Enter your email address to subscribe to this blog and receive notifications of new posts by email.

%d bloggers like this: