This Scares Me: The U.S. Balance of Trade

[Divinus Arma]

Every country has something called a "Balance of Payments". It is essentially a summary of all trade comin into and going out of a country. It includes goods, services, securities, assets purchased, foreign direct investment, etc.

I am currently doing a research paper on the U.S. Balance of Payments from 1985-2005.

Take a look at this;


This graph summarized three components of the Blance of Payments: (1) The current account, which measures goods and services imported/exported, (2) The Capital/Financial Account, which measures financial trade and diresct investment abroad or within the U.S., and (3), the U.S. Basic Balance, which essentially describes the international economic activity of a nation.

Anyway, here is what matters, and what we are starting to hear more of.

Look at the current account. It was relatively stable until 1997, staying in deficit always less than $200 Billion. In the last 8 years, it plummeted to more than $800 billion! That is a radical shift in trade in a very short amount of time.

Also, look at the capital/financial account. It has grown at the same rate (which is normal:the current account and capital/financial balance have a natural inverse relationship), to $800 billion. Why is this bad? Because all of that money is from foregin direct investment into the U.S.! It means that more and more international businesses are building subsidiaries in the U.S. and sending their cash back home.

Basically, these two figures tell us: The United States is rapidly losing its competitive edge as a global exporter, and our market economy enables foreign companies to build plants here and export out or sell from within.

Our trade base is taking the biggest crap in American history!

[Papewaio]

The silver lining is that all this foreign investment means there is a vested interest (forgive the pun) in keeping the US economy pumping along.

Also by importing so much oil at such a high price it is not helping things. I wonder how much of that trade balance would disappear by putting in alternative energy and nuclear power stations. Have more hybrid cars that can hook up to the power grid, a larger more efficient public transport network and less toys.

[Peasant Phill]

What is, in your opinion (or that of Greenspan or of someone else with some authority), the reason for this and what are the possible consequences if this situation continues?

[Major Robert Dump]

where, in relation to all of this, would products manufactured by a US company at a foreign plant to be shipped back to the US fit into all of this? Do shoes made by Nike in India to be sold in the US count as exporting or importing? And what about when a guy in India processes my insurance claim from Geico? Seriously, I'm curious how this figures in.

We are a consumer nation who demands low prices and convenience for almost everything,
Foreign investors want to make sales, so they come here and fill the vacuum, and there is a vacuum.
They also know we have a corporate tax code that can be worked like a cheap hooker, and a business bankruptcy system that holds no one acountable.

What do we have to export that is manufactured here that people would actually buy except basic foodstuffs, items of luxury and products that sell soley because of name recognition? I suppose we could export more "services", but we are at a disadvantage as a consumer nation because the bulk of services we use are low end services that can be done cheaper by the people where we are exporting to. That leaves high end services to be exported.

Of course theres also the international laws that tax the hell out of exported products to countries where they don't want us to compete, while their products being shipped over here are barely taxed.

I also think employee/employer loyalty, the rich/poor income gap and overall apathy and greed among certain elements of society make for a market thats easy to make some quick bucks, but offers lower qaulity products that you can't export because they are crap.

[Ser Clegane]

Do shoes made by Nike in India to be sold in the US count as exporting or importing?

I'm pretty sure that counts as import into the US (why shouldn't it? - where the headquarters of a company are located should be pretty irrelevant for this kind of statistic)

[drone]

On the flip side of that, do foriegn cars made here in the States count as imports? Say, BMWs built in South Carolina?

[Ser Clegane]

On the flip side of that, do foriegn cars made here in the States count as imports? Say, BMWs built in South Carolina?

No - the cars are made domestically (OTOH the investment by BMW to build the plant would fall under "foreign direct investment" that is reflected in the "Capital/Financial Account Balance" on DA's chart)

[stalin]

The funny part of the debt is when you check who USA's biggest creditor is...

Spoiler Alert, click show to read: 

[Divinus Arma]

To answer some of the questions here:

What is, in your opinion (or that of Greenspan or of someone else with some authority), the reason for this and what are the possible consequences if this situation continues?

This is exactly the point of my research.

The data tells us that since 1997, the United States has experienced a precipitous decline in international trade, taking in far more than it exports. Furthermore, international investment into the United States has grown at an equally rapid pace. In its analysis of the current account decline since 1991, the Congressional Budget Office (2004) wrote: “The fall in the current-account balance since 1991 reflects the fact that U.S. residents collectively spent increasingly more than their income (Par. 2)”. Since this is a national summary, the extra financing must come from outside of the U.S., and this financing is demonstrated by the inflows from the Financial Account. The Congressional Budget Office also wrote: "Between 1991 and 2003, cumulative net borrowing from abroad raised the nation's net obligations to the rest of the world by $2.1 trillion, to a record $2.4 trillion, or 22 percent of gross domestic product (Par.4)".
A number of factors have contributed to the decline of the Current Account and the corresponding rise in the Capital and Financial Account. The Congressional Budget Office explained that rising demand for dollar-based assets stimulated a decrease in interest rates and resultant U.S. investment in foreign currency.

CBO Commentary (2004)

In sum, we are accruing a huge amount of foreign debt while failing to match that debt with income from exports.

where, in relation to all of this, would products manufactured by a US company at a foreign plant to be shipped back to the US fit into all of this? Do shoes made by Nike in India to be sold in the US count as exporting or importing? And what about when a guy in India processes my insurance claim from Geico? Seriously, I'm curious how this figures in.

On the balance of payments, foriegn owned subsidiaries count as imports to the home nation. In other wors, a BMW plant in the U.S. headquartered in Germany counts all U.S. sales from that plant as income to Germany. Even though the plant is in the U.S., it is still an export to America. This is because the profits from subsidiary are sent back to Germany. The consolidated baalnce sheet of the German company counts its foreign operations as an export out of Germany. A U.S. plany abroad would count as a U.S. Export. So if Nike builds a plant in INdia and sells to residents in that country, it is technically an export. This is because the profits are sent back to the U.S. and accounted for uin U.S. Dollars after currency exchange is conducted. There is a spectrum of"exporting", rangin from simple exporting such as buying online and shipping abroad to wholly owned foreign subsidiaries. Either way, the profit goes back to the home country, irrespective of the value chain that delivered the product to the customer. The guy in India is neither an export nor an import. It is actually a domestic service, despite its nature as a "re-import".

I'm pretty sure that counts as import into the US (why shouldn't it? - where the headquarters of a company are located should be pretty irrelevant for this kind of statistic)

The headquarters of a company determines its national ownership, and therefore, the currency it does its accounting in. A U.S. firm doing business in Australia must exchange all Aus$ to US$ before it can document gains or losses from the Australian operation. Those US$ profits are then distributed to shareholders via dividends. Sure, foreign investors can purchase sahres of a U.S. firm. That is represented in the Capital/Financial Account as foreign financing. The foreign ownership of U.S. firms. The money that is given to them is considered a financial "export" for accounting purposes.

On the flip side of that, do foriegn cars made here in the States count as imports? Say, BMWs built in South Carolina?

Yes. Because the ownership of the company is foreign and the profits are sent back to germany. A U.S. citizen who hold shares in BMW would count as U.S. investment abroad and the money sent back to him would count as an export from the U.S. in terms of financing; we are exporting our financing in that case.

No - the cars are made domestically (OTOH the investment by BMW to build the plant would fall under "foreign direct investment" that is reflected in the "Capital/Financial Account Balance" on DA's chart)

Foreign direct investment actually means just that. If the German company is owned entirely by German nationals, than the profits are retained by germany. Thus the goods are exported from Germany and the financing is exported from Germany. The sale counts as an outflow and the financing counts as an inflow. This creates the inverse realtionship of the current account and the Capital/Financial Account.

By the way, the unfiltered data on this can be found here: http://www.bea.gov/bea/di/table1.xls

[Ser Clegane]

Just to clarify:
The revenues for a BMW car that has been manufactured in the US do not count as an import (other than the revenues for a BMW shipped in from Germany

[Divinus Arma]

Just to clarify:
The revenues for a BMW car that has been manufactured in the US do not count as an import (other than the revenues for a BMW shipped in from Germany

Look at it this way:

(1) A German company operates solely in Germany. They have neither exports nor imports for accounting purposes in Germany, and this activity is not counted as an international transaction on the German BoP.

(2) A German company manufactures the product entirely in Germany, with German based resources. The German company than sells the product to an American buyer using an export/import third party company. This international transaction appears as an export on the German BoP and an Import on the U.S. BoP.

(3) A German company manufactures the product entirely in Germany, with U.S. based resources. The German company than sells the product to an American buyer using an export/import third party company. The purchase of the U.S. based resources count as an import on the German BoP and an export on the U.S. BoP. The sale of the final product appears as an export on the German BoP and an Import on the U.S. BoP.

(4) A German company manufactures the product entirely in the U.S., with German based resources. The German company than sells the product to an American buyer using a German sales subsidiary based in the U.S. The purchase of the German based resources do not count as an international transaction on the BoP because they are being purchased by their own national-based company. The sale of the final product appears as an export on the German BoP and an Import on the U.S. BoP. The ONLY difference from example #2 was that the firm happened to build its product in overseas. The profits from the sale still return to Germany.

(5) A German company manufactures the product entirely in the U.S., with U.S. based resources. The German company than sells the product to an American buyer using a German Sales subsidiary based in the U.S. The purchase of the U.S. based resources count as an import on the German BoP and an export on the U.S. BoP, even though the product is produced in the U.S.; this is because the buyer is foreign-based. The sale of the final product appears as an export on the German BoP and an Import on the U.S. BoP.

I hope this helps to clarify it.

[Xiahou]

DA, why should I be concerned about this when it's coupled with consistent, strong economic growth and ever increasing worker productivity. The United States generates fantastic amounts of wealth, I dont necessarily see it as a cause for alarm that we're importing goods from other countries. I posted an article to this affect from Investor's Business Daily not too long ago.

As a side, some seem to be confusing government budget deficits with trade deficits- they are not the same.

[Ser Clegane]

(5) A German company manufactures the product entirely in the U.S., with U.S. based resources. The German company than sells the product to an American buyer using a German Sales subsidiary based in the U.S. The purchase of the U.S. based resources count as an import on the German BoP and an export on the U.S. BoP, even though the product is produced in the U.S.; this is because the buyer is foreign-based. The sale of the final product appears as an export on the German BoP and an Import on the U.S. BoP.

I hope this helps to clarify it.

I still believe that you are incorrect here.

To quote some BEA-definitions:

Imports of goods and services. Goods and services purchased by U.S. residents from foreign residents.
[...]
Foreign residents. Individuals, governments, business enterprises, trusts, associations, and nonprofit organizations that fulfill two criteria: (1) They have their center of economic interest outside the United States, and (2) they reside, or expect to reside, outside the United States for one year or more. Included in this definition are U.S. individuals living abroad for one year or more who are not employed by the U.S. government, foreigners residing in the United States for less than one year, and foreign affiliates of U.S. companies. In addition, foreign nationals employed in the United States by their home governments, foreign students enrolled at U.S. educational institutions, and international institutions located in the United States are also considered foreign residents.

BMW of North America, LLC is an enterprise that clearly has its economic interest primarily inside the US.
It is a US affiliate of a German company, however, as goods that are shipped into the US from foreign affiliates of US companies are considered to be imports, it should be clear that domestic sales of US affiliates of foreign companies are not.
Of course any services the US affiliate (of e.g. BMW) receives from their (in this case German) corporate headquarter would be imports, just as any profit transfers to the parent company would be exports.

[Divinus Arma]

An affiliate is different from a wholly owned subsidiary. An affiliate is either a company merely realted to another company in some way (the broad definition), or a company in which another company has a minority interest. A foriegn affiliate of a U.S. company is one in which the U.S. company has a minority interest. In these cases, profits from the affiliate are reported in the country where based. For example, China's government prohibits foreign firms from owning a majority interest in any Chinese operation. McDonald's in China is actually a U.S. affiliated Chinese owned company. The U.S. firm grants license to the chinese company to use its name, products, etc. I'm not 100% sure of the exact arrangement, but I do not that the firm is majority owned by Chinese nationals.

As for BMW, it depends on whether or not the affiliate conducts its consolidated balance sheet in the U.S. or Germany, and that is based on which nation has the majority interest in the affiliate company. If it sends its profits back to Germany, than it is wholly owned. If it reports its profits stateside, than it is an American-owned affiliate with licensing rights granted by BMW. In this case, it pays fees and royalties for the right to manufacture and sell within the U.S. under the BMW name, but does not send its profits to Germany for tax and accounting purposes.

BMW Manufacturing Co, LLC, in the U.S., is "a subsidiary of BMW AG in Munich", according to its website.

According to the 2005 Annual Report, the BMW group reports its income in Euro on its balance sheets. That means it sends its cahs back to Germany, and sales in America are considered exports from Germany.

Here's an odd one: A U.S. tourist making a purchase abroad counts as an import into the U.S.


But all of this is a minor point. The issue at hand is that the United States may be facing a serious currency crisis. One of two things are going to happen very soon:

(1) As it stands now, the USD is the international currency reserve due to its stability, and more importantly, the ability of U.S. firms to provide the highest return on assets in the world. If the U.S. can continue the trend of high RoI, then the world will essentially remain on "The Dollar Standard", and then that will mean that high current account deficits do not matter. This is a theory proposed by Alan Greenspan, and it explains why he believed that the greater threat to the U.S. economy was deflation, not inflation, and thus his policy of low interest rates.

(2) The U.S. is unable to sustain its entreprenuerial and technological advantage. In this instance, ROI will be greatly impacted, and the Euro will replace the dollar as the world reserve. The Dollar would devalue fairly quickly, causing a severe economic recession in the States, which in turn would result in catastophic recession in Asia, since theirs is an export economy entirely. Furthermore, the reduction in the Dollar value would cause international U.S. securities to lose big time against the Yen, Yuan, and Euro, triggering further flight from the greenback.

Most analysts believe that option #1 is most likely, since the U.S. economic and political sysetm isn't in danger of changing too much. However, if Democrats take control of the house, we will see an immeidate increase in the federal minimum wage as well as a mountain of new regulation due to "global warming". These regulations, coupled with higher input costs could be just enough to limit RoI in the states to turn investors towards Euro based securities. That would result in scenario #2.

Analysists do agree that both scenarios are possible. It depends on what happens to congress this year. Massive regualtion and socialization works in the Euro zone where GDP growth is 0% and based on a domestic economy and exports rather than RoI. The same type of economic sysetm would greatly damage the U.S. economy, which would have global shockwaves.


Edit:
Bottom line: If Democrats gain the House, BUY GOLD and as soon as possible. It will skyrocket as a hedge against currency instability and dollar devaluation.

[Major Robert Dump]

yeah, but minumum wage would go up, which means the price of fast food would go up, so there wouldn't be as many fat chics. I'm just sayin

[Vladimir]

Aren’t we looking at this in a relatively “old fashioned” way? It seems like this discussion could be rephrased as: Our village buys more stuff from other villages than other villages buy from us. Don’t forget that money’s a symbol and most of what matters is perception. Our trade deficit has been growing while our economy has been booming and I really don’t see the problem. There could be a national defense argument but the whole lines on a map thing is becoming as blurred as when nations began to form in the first place.

It's not like we're getting any poorer if we can afford to buy so much more stuff from overseas.

[yesdachi]

yeah, but minumum wage would go up, which means the price of fast food would go up, so there wouldn't be as many fat chics. I'm just sayin

I think the US should increase the export of them.

[Ser Clegane]

An affiliate is different from a wholly owned subsidiary. An affiliate is either a company merely realted to another company in some way (the broad definition), or a company in which another company has a minority interest. A foriegn affiliate of a U.S. company is one in which the U.S. company has a minority interest. In these cases, profits from the affiliate are reported in the country where based. For example, China's government prohibits foreign firms from owning a majority interest in any Chinese operation. McDonald's in China is actually a U.S. affiliated Chinese owned company. The U.S. firm grants license to the chinese company to use its name, products, etc. I'm not 100% sure of the exact arrangement, but I do not that the firm is majority owned by Chinese nationals.

As for BMW, it depends on whether or not the affiliate conducts its consolidated balance sheet in the U.S. or Germany, and that is based on which nation has the majority interest in the affiliate company. If it sends its profits back to Germany, than it is wholly owned. If it reports its profits stateside, than it is an American-owned affiliate with licensing rights granted by BMW. In this case, it pays fees and royalties for the right to manufacture and sell within the U.S. under the BMW name, but does not send its profits to Germany for tax and accounting purposes.

BMW Manufacturing Co, LLC, in the U.S., is "a subsidiary of BMW AG in Munich", according to its website.

According to the 2005 Annual Report, the BMW group reports its income in Euro on its balance sheets. That means it sends its cahs back to Germany, and sales in America are considered exports from Germany.

Sorry to be persistent - but do you have any source that backs up these definitions? Because this is certainly not a minor point when it comes to interpreting trade balances.
If for example products manufactured by subsidiaries of US companies and shipped to the US count as imports (and you are saying that this is not the case) this would have quite substantial impact on how a negative trade balance can be interpreted.
See the following article for what I mean:


The US Trade Deficit does not Spell Doom

Trade between foreign affiliates (as offshore subsidiaries are called) and U.S. companies and consumers can either inflate or diminish the current account balance. When Ford or General Motors produce vehicles in Mexico they sell many to American consumers, causing U.S. imports to rise. But they also sell a significant number in Mexico, generating a positive income flow to the U.S. current account, and they use technologies and components produced north of the border, boosting U.S. exports.

Any net negative impact on the trade balance caused by foreign affiliates is more of an accounting anomaly than a cause for economic concern. Methods for measuring the current account date back to the 1940s, when few companies had operations outside their home countries. Today, many companies have established subsidiaries abroad to tap new markets and take advantage of lower labour costs. Trade accounting methods have not kept pace with these changes: goods bought from U.S. foreign affiliates count as imports on the current account, even though American companies produce them.

Ford Mexico is BTW listed as a subsidiary in the 10-K report of Ford.

[Divinus Arma]

Sorry to be persistent - but do you have any source that backs up these definitions? Because this is certainly not a minor point when it comes to interpreting trade balances.
If for example products manufactured by subsidiaries of US companies and shipped to the US count as imports (and you are saying that this is not the case) this would have quite substantial impact on how a negative trade balance can be interpreted.

From Eiteman, Stonehill, & Moffett (2004) Multinational Business Finance (10th Ed.):

The financial Account: Financial assets can be classified in a number of different ways including the life of the asset (its maturity) and the nature of the ownership (public or private). The Financail account, however, uses a third method to classify financial asstes; the degree of investor control over the assets or operations. The financial account consists of three components thus classified: direct investment, in which the investor exerts some explicit degree of control over the assets; portfolio investment, in which the investor has no control over the assets; and other asset investment.

Direct Investment: If a U.S. firm builds a new automotive parts facility in another country or actually purchases a company in another country, this is a direct investment in the U.S. Balance of Payments accounts. When the capital flows out of the U.S., it enters the balance of payments as a negative cash flow. If, however, a foriegn firm purchases a firm in the United States, it is a capital inflow and enters the balance of payments positively. Whenever 10% or more of the voting shares in a U.S. company are held by a foreign company are held by foreign investors, the company is classified as a U.S. affiliate of a foreign company, and a foriegtn direct investment. Similarly, if U.S. investors hold 10% or more of of the control in a company outside the United States, that company is considered the foreign affiliate of a U.S. Company.

Now, that just discusses capital inflows and outflows from purchases or manufactur of plant and equipment. With these definitions in mind, consider this:

The second major source of concern over foreign direct investment is who recieves the profits from the enterprise. Foreign companies owning firms in the United States will ultimately profit from the activities of the firms.

So to clarify: Foreign capital that is used to build the plant, equipment, and products in the U.S. is considered an inflow (import) on the Financial Account. Once sales are conducted within the U.S. and the money is sent back to the home country, it counts as an outflow (export) on the Current account. This is shown as the inverse realtionship of the Current Account and the Capital/financial Account.

Does this makes sense?

A company wholly owned by the U.S., who produces abroad, for reimport into the U.S. should not count as an import. We cannot import to ourselves. Nor is it an export. We don't export to ourselves either!

If your article is accurate, than this statement is the most telling and relevant:

Trade accounting methods have not kept pace with these changes: goods bought from U.S. foreign affiliates count as imports on the current account, even though American companies produce them

I may be wrong on the designation, and If I am, than this means that the current account is inflated. This would makes sense, as the practice of producing abroad for resale into the U.S. is growing at a rapid clip. I wonder how much the current account is inflated? Edit: just a reminder the data used to produce the graph is offical U.S. Government data. Somebody needs to go punch the Gov in the nose!

Good gouge buddy. Nice work.

p.s.: A gentleman concedes to the more effective argument; A scholar makes the more effective argument his own.

[Atilius]

Mostly on topic:

P. J. O'Rourke on the US trade deficit with China. This is a bit flippant but he makes a few perceptive points. Here's a short excerpt:

But there is no such thing as a trade imbalance. Trade can't be out of balance because a balance is what a trade is. Buyers and sellers decide that one thing is equivalent to another. Free trade is balanced trade. You might as well have free love then claim your partner had sex but you didn't. And a certain American president did claim that. Maybe Monica Lewinsky is in charge of America's China policy.