Importance of Free Trade to the US

No contentious issue has more agreement among economists than that trade protectionism is detrimental to all concerned. Yet no issue is less understood by the public and politicians.  The typical claim is made that high wage countries cannot compete against countries where labor is exploited by low pay and terrible working conditions. By that reasoning California and New York cannot compete against Arkansas. In addition to huge wage differentials between California and Arkansas, there are no trade, legal, or language barriers to contend with. Therefore, according to arguments of trade protectionists, there should be massive outsourcing to Arkansas, Louisiana and Mississippi from California and New York. Obviously, this has not happened. Also, wages in Japan skyrocketed relative to US wages throughout the post war period with no effect on their huge trade surplus.
Image of globe in networkThe genesis of persistent trade imbalances has only a little to do with wages and working conditions. To understand why, we must start with the basics. When I get a haircut, I have established a trade deficit with my barber. He can take the money and buy something from me, buy something from someone else, or save the money. This same scenario can be aggregated to a nation as a whole. When we purchase clothing made in China, the Chinese have the same three choices as my barber. In recent decades the net of all such choices by citizens around the world outside the US has been to save much of the money earned through trade.
Now, having saved a chunk of the money earned through trade, our frugal foreigners must choose what to do with the dollars they have not spent. They can trade the dollars for other currencies, or they can invest those dollars in the US. The overwhelming choice has been to invest in the US because of the relative strength of our political economy. That is exactly equal to our trade deficit. As our economy weakens in combination with profligate monetary policies our currency will lose value.
Sideshows like currency devaluation, overvaluation and manipulation are irrelevant to our trade deficit. No amount of currency devaluation by our treasury will reduce our trade deficit as long as we spend and foreigners save. Our currency has plummeted over the past 40 years, sometimes so fast as to be on the verge of utter collapse, yet the trade deficit soared. The value of our currency is a sensitive barometer of the strength of our political economy and something that touches every one of us every day. It is insane to want that measure reduced in value.

Prior to WWI, as a debtor nation, our borrowing and spending was primarily for investment purposes (as in capital equipment). Today the trade deficit is for consumption. The consequences are very different. When we borrowed for investment our currency strengthened along with our economy because we were increasing our productive capital. Our borrowing for consumption means we have literally consumed – actually hocked – our productive capital.
Until now the effects of profligate money printing and extreme economy wide debt have been muted because foreigners have considered the US a great place to invest their savings, though at reduced exchange rates for our dollar. That is about to change.

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