The most closely watched economic statistic today is the Commerce Department's monthly report on the trade balance. Markets get nervous a day or two in advance, and rightly so. Not because the merchandise trade deficit is itself anything to worry about, but because the government reaction to any increase in that deficit really might be alarming. The trade-deficit malady is imaginary. But cures to imaginary maladies can do real harm.
In 1986 the United States ran a merchandise trade deficit of about $150 billion. But in the same year we also had an offsetting capital surplus. These aggregate numbers are difficult to grasp, so let me simplify things with a concrete example: I buy a videocassette recorder from Japan and pay $300 for it. My $300 goes to Japan, where it is exchanged for yen (let us assume at an exchange rate of 150 yen to the dollar). Not wanting to let the money lie idle, the Japanese monetary authorities send my $300 back to the United States in exchange for an interest-bearing U.S. bond.
What, at this point, is the "balance of trade"? I have a VCR, and it is working nicely. My $300 is back in the U.S. Treasury, and Japan is happy with its $300 IOU. We increase our goods, and we have a trade deficit; they increase their pieces of paper, and they have a trade surplus. We receive useful things like cars, television sets and VCRs. In return the Japanese show great confidence in the American system by accepting promises to be repaid in the future. Not a bad deal, you might think.
But wait a minute. Here come the scare-mongers and the doom-sayers. We are becoming a "debtor nation"; one day we'll have to pay the piper; all the good jobs are flowing abroad, and so on.
True, foreigners have lent us money. But there is a big difference between being sought out as an opportunity for investments and a haven for savings and begging for the dollars needed to continue subsidizing home consumption, Latin American style. What about jobs? Two years ago we kept hearing that as a result of the trade deficit we had "exported" 3 million jobs. In fact the United States has created 15 million new jobs since 1983. No (net) new jobs have been created in Western Europe since 1980, and West Germany, the proud possessor of a trade surplus, has lost 400,000 jobs since then.
It is furthermore illogical to worry that we owe foreigners money and therefore will have to pay them back at some point. Foreigners with investments and savings in the United States wish us good political and economic health as a result. Would those who worry about foreigners owning U.S. assets feel reassured if we resumed shipping billions of dollars to Mexico and Brazil as we did in the 1970s? If we repeated this to a sufficient extent we would indeed once again be able to call ourselves "net creditors"--on paper.
Now consider the dangerous part--the medicine for the misdiagnosed malady. Some Reagan Administration officials have accepted the theory that the dollar must be encouraged to sink in value in order to restore "balance" to trade. Since the Federal Reserve can indeed sink the dollar (by creating new dollars, thereby devaluing the ones that already exist), currency speculators with huge flows of capital passing through their hands try to anticipate the government response (that is, the lower-valued dollar), exchanging dollars for (let us say) yen, thereby causing the very dollar drop that they are trying to anticipate. Down comes the dollar to 125 yen, approximately its present level.
A while back, remember, I bought my VCR when the dollar was worth 150 yen, the exchange rate when the Japanese exchanged my $300 for a U.S. bond. Now let's suppose that they want to redeem the bond and exchange it back into yen. Suddenly they find it worth one-sixth less than they had anticipated because of the exchange-rate drop, which in turn was created by nervous capital movements. These were prompted by an attempt to outguess monetary manipulation by U.S. officials who may have been trying to "do something" about the trade deficit. And all the while some economists and politicians keep saying that we have this terrible trade-deficit problem!
Now what do you think foreigners do when they have investments in this country and they wake up in the morning and read in the London Financial Times or one of the Tokyo papers that U.S. officials are saying once again that maybe the dollar hasn't come down far enough because the big, bad trade deficit hasn't gone away yet? They try to get out as fast as they can.
It is a perilous thing when government officials in a country as important to the world trading system as the United States so much as contemplate manipulating their own currency. A declining dollar rewrites the terms of all existing contractual agreements between Americans and their foreign trading partners. Business is largely a matter of honoring contracts, but how can you do business with someone when the units in which the contract is written mean different things on different days?