How Capitalism Will Save Us (52 page)

W
hy do countries like China buy U.S. Treasury bonds? As we explained earlier, it’s largely because American companies buy Chinese goods with dollars. When their Chinese trading partners convert the dollars to yuan, their government ends up with pools of dollars. A natural place for them is in U.S. Treasury bonds.

Fifteen years ago, foreigners held only 14 percent of our publicly traded national debt. Today it is over 33 percent and rising. Free-trade critics commonly portray this in ominous terms. They worry that it represents a loss of U.S. economic virility and that this debt could be a weapon used against us.

However, in the Real World, foreign investments help us. How? By increasing the size of the potential market for U.S. Treasury bonds. The result is greater market liquidity and thus lower interest rates. If Americans were the only potential buyers, U.S. Treasury bonds would need higher yields to attract enough customers from this smaller market. Who pays for the higher interest the government would pay to bondholders? You, the taxpayer.

It’s hard to see how a foreign nation could really use our debt as a weapon. If China dumped its $740 billion of Treasury securities, the price of Treasuries would plunge—which would mean China suffering a huge capital loss. But we would not lose our military strength. If anything, China’s investment gives us the advantage. If we defaulted on our bond payments, China would experience a catastrophic setback, damaging its own economy.

Fears of foreign nations holding U.S. debt have traditionally proved
groundless. Japan became a big buyer of U.S. Treasury bonds back in the eighties, and many people feared it would become stronger while America would decline. What happened? In the 1990s, Japan entered a decade-long recession because of its own domestic economic mistakes. By contrast, the United States enjoyed a long period of prosperity and an extraordinary wave of technological innovation. Companies such as Microsoft, Intel, Cisco, Apple, eBay, and Google emerged as vigorous examples of U.S. competitiveness.

What about other nations holding stakes in our companies? In recent years a number of countries in the Middle East and Asia set up so-called sovereign wealth funds (SWFs). They buy not only Treasury bonds, but also stocks and bonds of private-sector companies. The value of sovereign wealth fund holdings in the United States has been estimated at between $1.5 trillion and $2.5 trillion.

Many of these funds are investing on behalf of Middle Eastern governments—the largest sovereign wealth fund, for example, is in Abu Dhabi. Singapore and Norway also have major funds. Some feared SWFs would make investments or use their holdings for political purposes. So far these funds have been generally passive investors, and there has been little, if anything, to justify concerns. However, the key here is transparency—disclosing these funds’ investment criteria and major holdings.

Congress sought to encourage this very transparency when it passed the Foreign Investment and National Security Act in 2007. The legislation provides a framework for greater scrutiny when a foreign government or entity attempts to take actual or de facto control of strategically sensitive corporations.

Such precautions are perfectly reasonable. However, SWFs mainly benefit investors. Their pools of money help lift stock prices. The banking crisis would have been infinitely worse if sovereign wealth funds hadn’t poured tens of billions into beleaguered financial institutions such as Citigroup.

With the economic downturn, fears of foreign ownership have for the moment subsided; government has the opposite concern—foreigners cutting back on U.S. investment. The Bush administration’s weak-dollar policy, intended to slow those cheap foreign exports, was too successful in accomplishing that mission. We’re now suffering the consequences.
Unfortunately, the Obama administration has been no better than its predecessor at grasping the connection between foreign investment, free trade, and a strong, stable dollar. Why should investors and central banks around the world invest in U.S. assets when their value is steadily declining?

P
eople care about America’s trade deficit because they think it’s a sign of weakness—like a company losing money. The financial press regularly runs stories like one from the Associated Press that announced in 2005, “Trade Deficit Hits $58.3 Billion in January.” The story reported that this second-highest trade deficit in history was being caused by “Americans’ appetite for foreign consumer products and automobiles.”
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The record deficit was cited as proof that trade policies of the Bush administration were not working. In the recession of 2009, the AP reported, “Trade Deficit Falls for 7th Straight Month in February,” which was said to be “fresh evidence the economy’s downward spiral may be easing.”
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In fact, the story was the reverse. The smaller trade deficit was the result of anything but increased economic strength. Americans were buying fewer goods from overseas because they had less money in the recession. So what if the gap between imports and exports had narrowed? The United States was going through the worst recession in thirty years. How could that possibly be good news?

Trade deficits are meaningless.
Forbes
magazine has had a ninety-two-year trade deficit with its paper suppliers. We buy their paper so we can make money selling magazines. The company sells us paper because that’s their business. They don’t buy anything from us except, perhaps, a few subscriptions. What’s wrong with that?

Nothing. The trade between
Forbes
and its paper vendor is only one aspect
of our respective businesses. We’re buying more from them than they buy from us. But the transaction is mutually beneficial: We’re getting a product essential to the operation of our business. They’re getting money. A “balance of trade” exists in this equal benefit.

Remember, for an exchange to take place in a free market, both partners have to benefit. Similarly, American companies buy from Chinese companies because it is mutually beneficial. Wal-Mart, for example, may import more goods than it sells in China. Nonetheless, it extracts a huge benefit. The retail giant has built a hugely profitable business based on being able to offer low-priced products to its price-conscious American customers. And the customers benefit, too, from getting more value for their money.

In other words, a trade balance may at first glance appear “lopsided” because one trading partner may realize the benefit elsewhere—in another area of a company’s business, or in another sector of the economy.

Complaints about America’s “trade deficit” ignore the benefit realized by the United States in the form of capital that returns to the economy—as foreign investment in either Treasury bonds or equities that help corporations expand their businesses. It also ignores American companies’ exporting services and expertise overseas, such as Intel putting facilities in Malaysia that sell chips to Japan. People who decry trade deficits as an indicator that America is losing jobs often don’t know that jobs are being created elsewhere.

Writer Sheldon Richman aptly sums up the absurdity of trade-deficit fears:

Free-trade bashers don’t realize that America has had a trade deficit with the rest of the world for 350 of its 400 years. The only time America had a trade surplus was from World War I until the early seventies. If you looked only at trade flows, the U.S. economy could easily be mistaken for Zimbabwe writ large, and not the engine of the world’s prosperity that it actually is.

When it comes to evaluating the health of an economy, you need to look at the whole picture. A focus on the trade deficit ignores an economy’s ability to innovate. It overlooks flows of capital and the fact that foreign entrepreneurs and scientists and engineers still want to come to us by the hundreds of thousands each year.