Boiling it all down, countries sell products to foreigners( exports) in order to buy products from foreigners( imports). What we sell to foreigners— our exports— pays for what we buy from foreigners— our imports. Without capital flows, the value of all exports is the value of all imports. The idea of trying to expand exports while contracting imports defies all logic.
Which would you prefer: capital lined up on our borders trying to get into our country, or capital lined up on our borders trying to get out of our country? The answer isn’ t quite so obvious.
Politicians continue to frame the U. S. trade deficit with the rest of the world as costing us jobs. But, in the same breath, they love a capital surplus. With a capital surplus, politicians argue, foreigners are bringing capital into a country, which then creates jobs and productivity. But, ultimately, the reality has to be faced: if you want a capital surplus, you need a trade deficit.
Foreigners generate the dollar cash flow that allows them to buy U. S.-located assets by selling more goods to the U. S. and by buying less goods from the U. S. For foreigners who want to acquire dollars in order to invest in U. S.-located assets, they have to generate those dollars in some net fashion. The trade balance of a country is the value of all exports less all imports, which, in turn, is the difference between domestic production and domestic expenditure, and is also the difference between domestic savings and domestic investment.
The trade balance in balance of payments accounting terms is the counter-account to a country’ s capital balance. Thus, a country’ s trade surplus is also its capital deficit and its trade deficit is also its capital surplus. In order for the U. S. to have a net capital inflow, foreigners have to have a trade surplus with the U. S.
The trade deficit / capital surplus, in turn, determines the terms-of-trade. The terms-of-trade are the relative price of one country’ s goods in terms of another country’ s goods. The terms-of-trade are often referred to as the real exchange rate and are crucial to a country’ s trade balance and the composition of its exports and imports. In order to export less and import more, a country’ s goods have to become less competitive, i. e. that country’ s terms-of-trade have to improve, which is one and the same as a rise in the real exchange rate.
When a country’ s terms-of-trade improve, i. e. its real exchange rate appreciates, it means that foreign goods become relatively cheaper than domestic goods. Therefore, the citizens of the appreciated currency country will import more and export less, i. e. all of its goods become less competitive.
The terms-of-trade provide the exact, correct trade balance to meet the capital investment needs based upon the economic policies of the countries in question. If the U. S. were running good economic policies, such as tax cuts, sound money and free trade, we would expect to see the U. S. trade deficit increase. We would also expect U. S. goods to become less competitive relative to foreign products. The dollar should appreciate relative to other currencies, and, as a result, the U. S. would export less and import more and run a trade deficit. On a global level, capital would be moving from everywhere bound for the U. S.
EB5: What are your thoughts about Chinese investment in America and in U. S. businesses in general?
Dr. ABL: Regarding foreign investment in the U. S., I say the more the merrier and the bigger the better.
Which would you prefer: capital lined up on our borders trying to get into our country, or capital lined up on our borders trying to get out of our country? The answer isn’ t quite so obvious.
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