A study in the dynamics of international flows… #1

Is the US trade deficit a problem? Are we somehow incapable of competing in the international market? Is there anything good about being such a debtor nation to China? Is the US really losing jobs to other countries?

These issues are heated. People are passionate about their views. Yet, it seems most people don’t understand the dynamics of international flows of goods, services and capital and the like. So what are the answers?

I will write a series of brief posts into international flows.

A Trade Deficit can be good…

To get a grip on international economics, I first start with the basic principle of the balance of payments. The sub-accounts of international trade must balance to zero. The sub-accounts are broadly identified as the Current Account and the Capital and Financial Account. The Current Account involves trade of goods, services, incomes and unilateral transfers (like gifts). The Capital and Financial Account involves the sales of assets like real estate, stocks, bonds, government securities and even bank deposits.

In accounting, an import in the Current Account is offset by borrowing from foreigners in the Capital and Financial Account.

These sub-accounts balance to zero internationally. So if one account rises, the other account needs to fall. So if a country needs to increase investment from abroad, its Current Account balance will decline in the direction from a trade surplus to a trade deficit.

Take Norway for example back in the 1960s. They discovered that there were rich deposits of petroleum in the North Sea. Yet, Norway did not have the expertise, nor the equipment to extract the petroleum. So they turned to other countries for help. They imported equipment and paid experts to guide them. Norway offset this by financing the operation with foreign capital. Norway quickly realized a trade deficit. Yet, offsetting its imports with borrowing led to a zero balance of payments. Imagine receiving those foreign loans and then using that money to buy imported equipment and services. The two actions balance each other in international flows.

Norway became a net debtor nation.

It is important to realize that as Norway borrowed so much money from abroad, their Current Account had to turn negative. Many people don’t realize the effect of international borrowing. If a country has to borrow lots of money, they will most likely end up with a trade deficit (more imports than exports) to balance the borrowing.

Was Norway’s trade deficit bad? No… The trade deficit was a natural process of investing in future economic growth that Norway would eventually profit from. And so, eventually the petroleum started to flow and Norway started to make money. Their trade deficit turned into a trade surplus.

So the trade deficit had its purpose. All along the process, Norway’s Balance of Payments with the rest of the world maintained a balance of zero. Yet how a country invests while it is a net debtor nation is key. In saying this we keep the United States in the corner of our eye.

Eventually Norway became a net creditor nation and still is.

Here is a list of debtor and creditor nations as of 2010. Creditor nations at the top of the list. NIIP signifies “Net International Investment Position”. (source) The numbers in this list reflect the accumulated value of the assets owned by a home country in other countries minus the value of the assets that other countries own in the home country. These values accumulate through years of trade deficits and trade surpluses. Norway could run a moderate trade deficit now, and still continue as a net creditor nation.

creditor debtor nations