Paul Krugman Is Almost Right
Jude Wanniski
March 28, 2000


To: Paul Krugman, NYTimes
From: Jude Wanniski
Re: The Trade Deficit

In your op-ed column Sunday, Professor, you made the argument that a) you probably should not pay attention to the trade deficit, because it can't hurt you and b) you should pay attention to the trade deficit because it is unsustainable, and when it ends, we all go over a cliff. Some of your readers might add this to the pile of on-the-one-hand-but-on-the-other-hand columns you have written this year, but I think it is a superior effort because you almost have it right.

The first half of the argument is correct: "Obsession with trade balances has historically been a source of bad economic policies. It's probably for the best that state governments don't know whether their trade with other states is in surplus or deficit; their ignorance keeps them out of mischief. And not paying attention is almost as good as not knowing." The reason nobody cares enough to collect these statistics is that we have a common currency -- the dollar is the unit of account for all 50 states. If one state sends more goods to another state than it receives in return, the difference is made up by an exchange of debt or equity. The state should have no concern about the ups and downs of trade flows that are the net result of private transactors between Chicago, say, and Bogalusa, LA. You know, of course, that New York City and Chicago run perpetual deficits in the merchandise trade deficit. Folks in those cities import all the food, clothing and building materials they need, and in exchange provide intellectual services, including instruction at the University of Chicago.

The second half of your argument is incorrect: "[J]ust as even the newest of new economy companies must eventually justify its existence by returning money to investors, even the most successful economies must sooner or later export enough to pay for its imports." Nation states are different than companies, Dr. Krugman, which means there is a slight difference which is critically important, and which you should have known about. In a reductio ad absurdum, suppose the United States is the only country in the world that conducts correct (supply-side) economic policies, and all the other countries of the world are ruled by economists trained at Harvard and MIT? Over time, everyone in the world will want to move to the United States in order to benefit from our wonderful economic system, and to escape from theirs. What then? If everyone in the world lives in the U.S., all those trade deficits we are running will never have to be paid back, as you insist is the "problem" we face. Years ago, when you were still in knickers and there were screams about our trade deficit, I made the point that when Rupert Murdoch gave up his Australian citizenship and became an American, all those trade deficits we had with Australia were reduced by the amount of his assets transferring to the U.S. Know what I mean?

The more fundamental error in your column, Professor, is in stating that "at least some of the money we are now pulling in is being brought in under false pretenses." False? False? Why false? You say foreigners are willing to hold U.S. government bonds because they believe the U.S. dollar will continue to remain strong for the next 10 years. "But the size of our trade deficit makes that unlikely," you say. I beg to differ, Professor. The dollar can remain strong as long as the Federal Reserve makes few errors in the management of the currency and that our government's tax and regulatory system remains hospitable to private business. When you say foreign investors will be in for a "rude shock" when the dollar plunges in value, you are jumping to false conclusions. Is it not possible, Dr. Krugman, that sometime in the very near future, the rest of the world will suddenly look like a good investment to Americans? That is, when we are working at top speed and can't squeeze another drop of production out of our working-age population, it will make sense for us to invest in the rest of the world, net net. You must acknowledge, I think, that instead of falling off a cliff as you suggest, we would then run down our trade deficit by exporting capital instead of importing it. That would be a nice thing to happen, wouldn't it? I know they did not teach you this kind of economics when you were growing up, which is why you make so many little mistakes. You are getting better, at least half right this time. Up until now, I have given you an "F" on each of your columns. Be of good cheer. This one gets C-. Onward and upward.