International Trade – U.S. dollars flowing around the world

What are the implications of the U.S. importing lots of products from abroad? Does our trade deficit imply that we are getting ripped off and need to impose trade restrictions? For example, consider our trade with China. China takes its resources, and its people work hard producing products for us. In return, instead of sending lots of our products to China, we send them pieces of paper with George Washington’s picture on them (U.S. dollars). Ordinarily, all those U.S. dollars would find their way into the international currency exchange markets driving down the value of the U.S. dollar and raising the price of the Chinese yuan. That would make Chinese products more expensive for us to purchase and U.S. products cheaper for China to purchase.

You would think that making U.S. products less expensive for the Chinese people to purchase would be good for China. But traditionally most Chinese have been very poor and not able to afford even lower priced U.S. products. A more immediate problem for China’s government has been the flow of peasants from rural areas into the urban centers where products are produced for export. China needed a way to avoid high levels of unemployment and keep its citizens employed through the manufacture of products for export. Instead of allowing those U.S. dollars to go into the currency exchange markets, China used those U.S. dollars to buy U.S. Treasury securities. In other words, China gave us products, we gave China U.S. dollars, and China gave us our money back again by investing money in U.S. financial markets by buying U.S. Treasury securities. Who is getting ripped off here? (Hint: it is not us.)

Issuing a lot of U.S. Treasury securities attracts U.S. dollars situated abroad that would otherwise drive down the value of the U.S. dollar in international currency exchange markets. This makes it more difficult for the Federal Reserve to suppress inflation through the supply-side. Overseas investors, especially sovereign wealth funds, may move U.S. dollars into New York financial markets leaving a stronger U.S. dollar in international currency exchange markets than would otherwise be the case. Japan and China have purchased large quantities of U.S. Treasury securities with U.S. dollars that would otherwise have gone to drive down the value of the dollar, which would have lowered the price of U.S. exports and increased the price of imports into the U.S. helping move toward a better balance in tradable commodities and services.       

However, some foreign governments (e.g., China) may have motives for investing in U.S. Treasury securities other than seeking an attractive return on investment in the form of interest payments. China requires that Chinese exporters turn in U.S. dollars to the Chinese government in return for renminbi (yuan) to keep those dollars out of foreign exchange markets. China’s return on investment in U.S. Treasury securities may be less in the form of interest payments and more in keeping its population fully employed to maintain both economic and political stability by maintaining either a low value for the yuan in international exchange markets or, somewhat equivalently, a high value for the U.S. dollar. 

It is important to consider the underlying cause of trade imbalances, especially those that have kept the U.S. dollar strong.  China and several European countries, for example, have highly unequal internal wealth distributions such that an insufficient amount of money is flowing to their average people to sustain full employment without substantial exports. In other words, United States consumers and other foreign consumers make up for the lack of adequate demand by China’s domestic consumers. The extreme wealth inequality in China and those European countries mean that the people in those countries cannot afford to buy back the value of the goods and services they are producing, but the wealth of those countries has gone to wealthy elites who are eager to invest their money in the United States financial markets. 

Even elites in poor, developing countries are often eager to invest their money in the New York financial markets instead of investing in industrial development in their own country. This phenomenon can be viewed as another form of colonial exploitation, with the development of poorer countries held back in favor of providing more wealth to the already wealthy by driving up prices in the U.S. stock market. The U.S. stock market, and stock markets in general, have become alternatives or substitutes for real investment in the productive capacity of economies throughout the world.  Simcha Barkai published a carefully researched paper that revealed that business revenues were going increasingly to profits (financial capital) as opposed to the cost of labor or real capital (e.g. physical or intellectual capital).

This distorted money flow has created a financial economy that is more and more separated from the real economy. Ironically, it has been restraining and undermining productivity and economic growth rather than supporting and encouraging it. Yes, money is cheap for businesses to borrow, but demand is chronically inadequate without extraordinary stimulus from governments. Businesses have no incentive to expand their operations, but instead they buy up or undercut smaller competitors to increase their market share and prices.

Another major reason for the strength of the U.S. dollar in foreign exchange markets is the role of the U.S. dollar as the world’s primary reserve currency. In order to avoid the instability and risk associated with fluctuations in the value of trading one country’s currency for another, some major entities purchase imports with U.S. dollars and sell exports denoted in U.S. dollars to avoid the ups and downs of the foreign exchange markets. Trade in crude oil and other major commodities is traditionally done in terms of U.S. dollars. Consequently, as international trade continues to increase over time, the demand for U.S. dollars increases to keep the U.S. dollar highly valued in foreign exchange markets. 

In other words, a country whose currency serves as a major reserve currency is in basically the same boat as a country that suffers from the natural resource curse, otherwise known as the Dutch Disease, a term coined by The Economist to refer specifically to how the value of the Dutch guilder was driven up when the Netherlands discovered massive amounts of natural gas within its territory, and generally to any country selling large quantities of a natural resource in high demand.  A reserve currency country and a country suffering from the natural resource curse have great difficulty selling their exports because of the high price of those exports in that country’s currency in the foreign exchange markets. In other words, under these circumstances the exports of the United States and the Netherlands would be basically priced out of international markets. The Dutch escaped the Dutch Disease by dropping the guilder and joining the Euro currency union where their natural gas exports were much less impactful with little effect on the strength of the Euro overall. As a reserve currency it is not only desirable, but necessary, for the country with the reserve currency to run a current account deficit to increase the amount of their currency in foreign exchange markets to keep from being completely priced out of the markets for its exports or see its exporting industries shrink as a result of its reserve currency status and the ever increasing demand for its currency in international markets.

On the other hand, the advantage of a strong currency are low prices for imports which save consumers money and helps make up for extreme income and wealth inequality within the United States. This is particularly helpful for retired elderly people who are on fixed incomes. In real terms the Chinese and other foreign producers are taking their natural resources and working hard to produce products for us, but instead of sending comparable products to them, we are sending them pieces of paper with George Washington’s picture on it (U.S. dollars). For the most part, tariffs on Chinese goods entering the United States are not paid by China. Walmart, in competition with other businesses around the world, buys goods in China and ships them to the United States. When those goods arrive in Long Beach, California, the Federal government requires that Walmart pay a tariff on those goods from China. Walmart can compensate itself to some extent by passing along the cost of the tariff to Walmart customers. Since many of the items Walmart buys from China are relatively inexpensive to begin with, the elasticity of demand for those items may be relatively high relative to the elasticity of supply so Walmart is able to get away with passing along most of the cost of the tariff to Walmart customers without suffering a significant drop in demand for those particular items. When the price of a great pair of Chinese memory foam sneakers rises from $9.98 to $12.48, it is still a great deal relative to alternatives.

The world works for us and we work for ourselves, yet we are told that we are being exploited by others by importing actual physical goods and services and paying for them with pieces of paper (U.S. dollars). The actual truth is the exact opposite of what those U.S. citizens who see themselves as “victims” tell us, the world is working hard and sacrificing their resources to keep us fat and happy!  In reality, we are the ones in the dominant and exploitative position in foreign trade. The absence of tariffs works to our advantage. The lumber and steel tariffs we placed on Canada only increased the cost of housing, automobiles and appliances in the United States. We need to remove those tariffs so we can get Canadian lumber and steel for less.

Yes, the overseas competition for the dollars of U.S. consumers means that the wages and jobs of U.S. workers are suppressed. Tariffs do not necessarily solve this problem since they would raise prices without guaranteeing that the money from the higher prices would go to workers in the form of higher wages and more jobs. Both the flow of dollars from abroad into U.S. financial markets in New York and the role of the U.S. dollar as a reserve currency in foreign trade have kept the value of the U.S. dollar strong in foreign exchange markets. The high value of the U.S. dollar makes U.S. exports expensive for people in other countries to purchase. A strong dollar means that we export less than we would otherwise and end up primarily producing our own goods and services for our own citizens.

The idea that there are a limited number of jobs in this world, and we must fight over them is what economists call The Lump of Labor Fallacy. The number and quality of jobs in the United States is not fixed. Fiscal and monetary policies can create as many jobs as we need. The current shortage of workers is in part due to stimulus policies that have been implemented in response to the COVID-19 pandemic. We should not raise prices in Walmart, Target, Amazon and many other low cost venues by imposing tariffs on imports coming from abroad. A better approach is to gain a tighter control over the number and quality of jobs here in the U.S. to keep our workers fully employed while still enjoying the low prices offered by imports from abroad.

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Lawrence C. Marsh (http://sites.nd.edu/lawrence-c-marsh/home/) is Professor Emeritus in Economics at the University of Notre Dame and author of the 2020 book: Optimal Money Flow: A New Vision on How a Dynamic-Growth Economy Can Work for Everyone (https://emeritipublishing.com/) .
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You can donate the entire purchase price of the book to student scholarships by buying a hard-bound copy of the Optimal Money Flow book at the Avila University Press website at:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh
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For additional details see the Optimal Money Flow book website at:
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or the 2018 "Money Flow in a Dynamic Economy" paper presented at 2019 American Economic Association conference in Atlanta, GA:
https://www.aeaweb.org/conference/2019/preliminary/paper/FT7A95eS
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The full purchase price will go into the student scholarship fund when purchased through Avila University Press at the link:  https://www.avila.edu/aupress/optimal-money-flow-by-lawrence-c-marsh
Link to my Notre Dame webpage (http://sites.nd.edu/lawrence-c-marsh/home/)

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2 thoughts on “International Trade – U.S. dollars flowing around the world

  1. Well I believe it is the US who is being harmed. First we lose jobs and eventually the ability to make important items. While this is fine for junk that we really don’t need not so good for drugs and other essential needs. Next China gets leverage by owning our debt, unless someone had enough guts to cancel it that is a bad thing for the entire world. Remember China wants power they don’t really care much for the people, just the power. And a trade deficit gets them power. Just my personal opinion.

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