I finished "Economics in One Lesson" not to long ago and liked it a lot. It's the first Economics book I've read that deals with Austrian Economics. I was convinced in pretty much everything it had to say, but the exports and imports part confused me a little.
http://jim.com/econ/chap12p1.html
According to Ch. 12 in "Economics in One Lesson", in the scenario in the 2nd paragraph, the British importers pays in pounds, then through exchange or direct buyback, someone in America must buy something from Britian because he can't use the pounds in the USA.
So if this scenario happened all the time, wouldn't our imports always equal our exports for each country we trade with? (at least for each different form of money)
I may be missing something here, but does Saudi Arabia import just as much from the USA as we do from it? This seems hard to believe, but I guess it could be true.
And also under this logic, doesn't it mean that the Euro actually hurts the economy of countries in Europe that import a great deal? Because Hazlitt's logic of exports must equal imports no longer applies because his logic is assuming that the trading countries have two different forms of currency. European countries that import pay for other European countries' exports in Euros, and is not neccesary that the exporting country pays them back in the form of imports, tourism, etc. The exporting country could use the money for anything they want.
It is probably just because I am simplifying the process too much. I'm trying to sort this out through my head, and I'm sure that I just have something screwed up in this logic.
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This Warren Buffet classic might help to clear some of the confusion: Squanderville Vs. Thriftville
Libertarian_for_Life:According to Ch. 12 in "Economics in One Lesson", in the scenario in the 2nd paragraph, the British importers pays in pounds, then through exchange or direct buyback, someone in America must buy something from Britian because he can't use the pounds in the USA.So if this scenario happened all the time, wouldn't our imports always equal our exports for each country we trade with? (at least for each different form of money)
First we need to distinguish between the term Balance of Payments, when you refer to currency flows of pounds, and the Balance of Trade, when you refer to exports and imports of goods and services.In international trade theory, the Balance of Payments must always be zero, such that the currency payments coming into a country must equal the currency payments coming out of a country. For the U.S., the amount of British pounds coming in must equal the amount of British pounds coming out. For Britain, the amount of U.S. dollars coming in must equal the amount of U.S. dollars coming out. This is because British pounds are useless for buying within the U.S., and likewise U.S. dollars are useless for buying within Britain. Therefore any Balance of Payment imbalance must be brought down to zero.In the absence of capital flows, the Balance of Trade must also be zero, such that the value of the exports must equal the value of the imports. Exports from the U.S. to Britain pulls in pounds, while imports to the U.S. from Britain pushes out pounds. Because the pounds coming into the U.S. must equal the pounds coming of the U.S., the value of the exports (in pounds) must equal the value of the imports (in pounds). Therefore to maintain a currency balance, the Balance of Payments must be zero, and the Balance of Trade must also be zero. However, there is a possibility the Balance of Trade can be in surplus, such that exports are greater than imports, even when the Balance of Payments is zero.
How is is that possible? Let say those in the U.S. want to make an investment in Britain. Investors must have pounds. For this to happen, imports must drop, while exports remain the same. Because exports are now greater than imports, the inflow of pounds (from exports) is greater than the outflow of pounds (to imports), thus there is a Balance of Payment surplus.
Having a Balance of Payment surplus means that the U.S. is stockpiling pounds it can never use within the U.S. To correct this currency imbalance, investors take the pound surplus and compensate by buying assets in Britain, whether equity or debt.Keeping the accounts in balance, the Balance of Trade is in surplus (more exports than imports), but this is canceled out by a Capital Account deficit (the U.S. investment in Britain). Because the Balance of Trade surplus is exactly offset by the Capital Account deficit, the Balance of Payments is brought back down to zero.
This can be expressed in an accounting equation:
Balance of Trade + Capital Account = Balance of Payments
Because Balance of Payments must equal zero:
Balance of Trade + Capital Account = 0
Balance of Trade (surplus) = - Capital Account (deficit)
In other words, even though the Balance of Payments is zero, such that all pounds coming in must come out, there can still be a Balance of Trade surplus (exports greater than imports) as long as its balanced out by a Capital Account deficit (net currency investment to Britain).
Libertarian_for_Life:I may be missing something here, but does Saudi Arabia import just as much from the USA as we do from it? This seems hard to believe, but I guess it could be true.
I will have to check the latest trade statistic for Saudi Arabia. But if Saudi Arabia sells oil to the U.S. for dollars, then either Saudi Arabia buys goods from or invests in the U.S., or buys goods from or invests in some other country who needs U.S. dollars.
Ultimately, the U.S. dollars are either stockpiled somewhere or returned to the U.S.
Libertarian_for_Life: And also under this logic, doesn't it mean that the Euro actually hurts the economy of countries in Europe that import a great deal? Because Hazlitt's logic of exports must equal imports no longer applies because his logic is assuming that the trading countries have two different forms of currency. European countries that import pay for other European countries' exports in Euros, and is not neccesary that the exporting country pays them back in the form of imports, tourism, etc. The exporting country could use the money for anything they want.
Let's take the example of Germany, a centrally located country in the EU. The same analysis above applies as to this situation, except most EU countries use the the Euro as the the currency of trade.
In all cases, to maintain a currency balance, Germany must have a Balance of Payments such that Euro in-payments from goods it exports must equal the Euro out-payments for goods it imports.
For Germany to import more than it exports, the Balance of Payments will be in deficit such that more Euros will leave Germany than entering it. This Balance of Payment deficit will continue until Germany runs down its Euro cash balance and must reduce the level of imports to equal the level of exports.
To avoid running out of Euros, while maintaining a Balance of Trade deficit, those in other EU countries must compensate by buying assets in Germany, either equity or debt. The Balance of Trade deficit is canceled out by the Capital Account surplus, bringing the Balance of Payments back to zero.
In the event Germany exports more than it imports, the Balance of Payments will be in surplus. More Euros will enter Germany than leaving it. But because there is no upper limit on how many Euros it can accumulate, it can stockpile as many Euros as it wants.
However, there are only so many goods that can be bought within Germany with all those accumulated Euros. Because of the increasing amount of Euros, the price level in Germany will rise, such that goods in Germany are more expensive than that of the neighboring EU countries.
Imports increase as Germans take advantage of lower prices outside of Germany. Exports decrease as those outside Germany are discouraged from buying at higher German prices.
More imports and less exports expunges the excess Euros from Germany, until the price level is brought down to a level equal to those of other EU countries.
More Euros within also means lower interest rates for Germany. Because Germany has lower interest rates than its EU neighbors, Germans will move the Euros to the other EU countries to earn higher interest rates. Borrowers from the neighboring countries will take advantage of the lower interest rates and borrow funds.
The Balance of Trade surplus will be canceled by the Capital Account deficit, resulting in a Balance of Payments of zero.
In general, the true wealth of nation is in how much it can produce. International trade increases the production of both trading countries, than either country can produce on its own. This is because trade allows both countries to specialize more in producing what it does best.
The Balance of Trade surplus does not make a country any richer. Neither can a Balance of Trade deficit make it any poorer.
For there to be a Balance of Trade surplus or deficit, simply means that one country is investing in the other country.
Libertarian_for_Life: It is probably just because I am simplifying the process too much. I'm trying to sort this out through my head, and I'm sure that I just have something screwed up in this logic.
International trade theory is very complex, so my post barely scratches the surface. But I hope this gives you at least a basic idea.
There's nothing wrong with your analysis, but it depends on what assumptions are made; in particular, what assumptions are made regarding where the currency can be used, and what expectations are of the current versus future valuation of the currency. (The paradigm that I use is that money is a commodity whose value changes with respect to other goods/services over time.)In a lot of these discussions, two things are important to consider:(a) Can the native currency be used only in the native country?(b) Does a foreign holder of a native currency wish to hold the currency into the future (for whatever reason)?If (a) is true and (b) is false, then we have the case of the British export example. The American holder of British pounds would exchange right away for some British good or service.If (a) is false, then we have the case of Saudi Arabia whose main export is oil which is currently sold on the international market in U.S. dollars. The foreign holder of a native currency can then exchange the currency for other goods/services either in the native country or internationally.Your Eurozone example is similar to the previous paragraph.***However, if you start playing with either of the two considerations (with the perspective that a money is a commodity), then I believe that you can start seeing what can be seen in many actual transactions in the world.In the simplest example, assume that there is only one currency that people value (e.g. gold); consideration (a) is false. Then, certainly, one country could export its goods and services and receive, in compensation, only currency. Then this exporter would be accumulating the currency. That currency can then be used anytime in the future to purchase other goods/services either domestically or from any other country; this depends only on the time-preference of the country for goods/services versus currency.In a slightly more complicated example, if consideration (b) is true but (a) is false (i.e. there exists a currency that is accepted for many international transactions, such as the U.S. dollar), then the options are the same as above. However, time-preferences can be affected by changing quantities of money; this might arise as a result of a currency being inflated/diluted (as is typical of fiat currencies). In this case, part of the consideration of the currency holder would be to compare its options: exchange the currency for some goods/services that can be consumed immediately; invest the currency with the expectation that the investment will outpace the effects of monetary inflation/dilution.If consideration (a) and (b) are true (i.e. a foreigner wants to hold the native currency), then the foreigner would be faced with similar options as above. A question that arises is why might a foreigner wish to hold the currency? Perhaps, the foreigner thinks that the currency is undervalued with respect to future native assets. (This could arise for many reasons including improperly fixed exchange rates; different foresight of the foreigner versus the current exchange rate [which may or may not be fixed]; different time-preferences of the foreigner versus others who exchange with the native country; etc.)
LOL I haven't gotten to that chapter yet
Think Blue,
Your post helped out a lot, I'm starting to understand about the Balance of Payments and Balance of Trade, thank you
But responding to socialdtk,
I'm trying to connect what I have just learned about Balance of Trade with the "Warren Buffet Classic" you linked me to. So if I'm getting this right, normally a Balance of Trade deficit is not bad because it would eventually be replaced soon after with a Balance of Trade surplus with the stockpiled currency from another country.
But under the USA situation (aka what Warren Buffet referring to) if we keep lending out bonds every single year and creating Balance of Trade deficits every single year, then we build a debt that is never getting paid off, is this what you are getting at?