Trade occurs when two parties agree to exchange one item for another as each party values the item he will receive as much as or more than what he is giving away. It sounds very basic, but this fact is often lost in talk of international trade.

As soon as we talk of international trade, people suddenly forget all the facts they otherwise understand. Some of this is the fault of the economists, the Keynesian silliness of macroeconomics ends up making people think of trade deficits and balance of payments and other aggregate measures rather than looking at the very basic fact that trade is always balanced, and is always between two individuals.

Now, I am sure I lost some people with that statement. We have heard about trade deficits for so long that we simply cannot believe they are not relevant, but, in many respects, they aren't. And why is that? Because, as I said at the start, trade is always between two individuals who agree to exchange, and thus trade is always balanced.

So, if that is the case, why so much talk about trade deficits? Because money obscures this fact. When we exchange money for goods, we are not immediately giving them any items in exchange, and so the myth develops that there is some deficit, as country X got money while we got goods. And somehow people think this makes us poorer and X richer. But the fact is that X must eventually exchange those dollars for good in the US, either directly by making a purchase, or indirectly, by buying from  someone in country Y who will then buy goods from us. Dollars are only good for eventually buying US goods², so unless they are going to hoard dollars, eventually our trade partners will eventually buy from us.

Now, given this truth, there remain three fears of those who worry about "balance of trade". First, that country X will not buy consumer goods, but instead purchase land. Second, that the foreign nation would use the money to "buy up" companies in our nation. Third, that country X will simply sit on the money and never buy goods from us. So let us look at those two possibilities.

The first is a familiar one. Back in the time of the gold standard the fear was that the foreign nations would exchange bank notes for gold and we would see an outflowing of gold. The fear of purchasing land or other non-consumer goods is of a similar nature. The problem with this argument is simply that there is no requirement that trade involve only consumer goods. Suppose there are two individuals in our nation, Al and Arthur, and one in a foreign land, Boris. Al buys a car from Boris' factory. Boris then uses the proceeds to buy Arthur's lot. I fail to see how this harms the US economy. Arthur wanted to exchange his lot for land, and did so, and Al wanted to exchange his money for a car and did so. That the transaction crossed national borders dos not make any difference to them. Everyone has what they want. No one is any poorer, and it just puzzles me how this "trade deficit" makes the US any poorer.

The second is even more puzzling. as attracting investment is something we want to do. In fact, attracting foreign investment is one of the ways that the richest nations have become that wealthy. It is a matter of indifference to employee whether or not their owners are from the US. If Ford opens a plant, or Toyota, the jobs are the same, the local economy benefits as much, it makes no difference. True the profits flow to shar eholders overseas rather than here, but what difference does it make?

But the third fear is the most puzzling. It is a revival of the strange beliefs of the mercantilists, the idea that we are richest if we force another nation to buy our goods, but sell us nothing in return. Both theories rest on confusing money with wealth.

Think of it this way. let us suppose Japan decides to adopt a perfect mercantilist system, they will provide us with any goods we want in exchange for dollars, but they will refuse to buy anything from us. What would happen? We would buy up Japanese goods, and they would sit on the dollars. Other than providing a slight deflationary pressure, the effect would be that we would effectively get Japanese goods for free. Dollars are of very little intrinsic value², their worth is in what they can purchase. If they are never used to purchase anything, then they are worthless. And that is why this fear seems so far fetched.

Now, I do not mean to oversimplify, the manipulation of fiat currency does make some of these questions a little more difficult. As the dollar loses value, we are effectively stealing money from foreign holders of dollars. But that does not change the basic fact that foreign trade is just trade. If I buy a car from Toyota, it is not "the US" buying from "Japan", I am just buying a car.

Let me approach this differently. I live in Maryland, but buy my clothes from a tailor in Virginia. When I buy my clothes, does Maryland get poorer and Virginia richer? Should I limit my purchases to my home state only? And if I do, should I limit it to the county in which I live so as not to impoverish my home county?

So, if that sounds absurd, why does it become more sensible when we replace state boundaries with national boundaries? Trade is still trade. I am giving up money or goods to get money or goods I value more highly, and the other party is doing the same. There is no national loss, no national gain, simply two individuals engaging in a mutually agreeable exchange.

I imagine that there are some out there who are about to object to this and start talking about "fair trade" and subsidies and national security. For the moment, I will refer them to my older essay "Protectionism" as well as "Exploiting Workers?". I will most likely write an updated version in the near future, but for now that previous work should be adequate.

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1. This is the point ignored by Obama who claimed to want to continue economic isolation of Cuba while allowing remittances to relatives from the US. How exactly would they then spend those dollars if trade between Cuba and the US is prohibited?

2. They have too much printing to be used as note pads, making them valuable only as kindling or toilet paper.