Tadpoles and Trade Imbalances

I really hate to do what I am about to do. I’ve done it many times over the years with a decent measure of success. With that success also came revulsion and displeasure from certain segments of the population who don’t believe they have anything to learn because they just ‘know’. You know, the angry political people. These are people whose thinking patterns are driven by anger when it comes to economics. And they only listen to certain political leaders, people, and institutions who speak to that anger. So, in this manner, they know everything that there is to know about macroeconomics. They do not need instruction, you see, unless that instruction comes from an angry expert who employs appeals to emotion as the basis for understanding the macroeconomy. Besides, it’s all opinion, right? Yeah, I’ll get to that in a moment.

Ironically, even with the rage, some of these folks are well-meaning people. Because they are well-meaning, and because I fully understand this particular subject, I know that they are completely wrong and I want them to understand how things actually work without offending them. But with what I am about to say,

Del Griffith: “We’d have better luck playing pick-up sticks with our butt cheeks…”

than not offending these individuals. A little ‘Planes, Trains and Automobiles’ reference for you.

You see, some well-meaning people who believe themselves to be well-informed and intelligent when it comes to macroeconomics and international trade will take great offense when they read this article. True, a few might not publicly admit that they’re offended. But in the quiet confines of their domiciles, they will either cry aloud or whisper under their breath that I am a “stupid, worthless, no good, goddamn son of a bitch, retarded, big mouth, know-it-all, asshole, jerk.” Yeah, it’s John Bender’s line from the ‘Breakfast Club’. Another John Hughes film. I left out the ‘freeloading’ part because it doesn’t apply here. I’m speaking to progressives here, not conservatives.

Speaking of ‘The Breakfast Club’, John Bender happens to be one of my favourite characters that Judd Nelson played. I like Judd. Bender demonstrates that appearances can be misleading. One might dress like a ‘burner’ and behave like one, but that doesn’t imply that the person is unintelligent, devoid of any future opportunity. Nor does it imply that the person is truly an anti-social jerk. Perhaps he has serious problems at home that make him feel worthless, he’s lonely, and he’s just trying to fit in with any crowd of people who will accept him. To do that, he must behave in a certain way; a way that the particular crowd approves of. Anyway. I got sidetracked there. You get my point I think. If not, then think about it for a bit.

Back to the main point.

So, these well-meaning people who believe themselves to be well-informed and intelligent when it comes to macroeconomics and international trade will call me a stupid, worthless, no good, goddamn son of a bitch, retarded, big mouth, know-it-all, asshole, jerk. They think that I am all high and mighty and arrogant because I’m using a simple example to demonstrate why, in reality, they are misinformed and not so intelligent when it comes to macroeconomics and international trade. They feel that I am ‘talking down’ to them. I am being ‘snooty’:

Maître d’: “I suggest that you leave before I have to get snooty.”

Ferris Bueller: “Snooty?”

Maître d’: “Snotty.”

Ferris Bueller: “Snotty?”

Damn it. I must have contracted the John Hughes virus this morning.

Anyway. Their response is how I know that I’ve gotten across to these individuals. They realise that certain concepts are really quite simple, that they were totally wrong, and now they are embarrassed at all of the conspiratorial-minded anti-knowledge they’ve passed around on social media. The problem is the anger. Their anger drives them to stay the course and not admit that they were wrong. The social consequences for doing so would be too great. Friends might poke fun at them. Others might no longer consider them to be someone who knows their stuff and refuse take them seriously anymore, costing them their status and any position of influence they’ve managed to attain. Some individuals just don’t wish to admit to themselves that they were talking nonsense. They just do not want to be wrong ever, ever, ever. Who knows, and who cares? The point is, it’s going to happen whether they make it known or not. And the core reasons why are because 1.) I, in fact, know what I am talking about, but I do not speak to their anger, and 2.) since macroeconomics unavoidably intermingles with politics they believe that macroeconomics, like politics, is all just opinion.

They reason that everyone is allowed to have an opinion in politics so the same must apply to macroeconomics and I am just voicing one opinion; an opinion which they claim is wrong. Look, I cannot do anything about the former. If they wish to drown in a sea of anger and peddle fear, then all I can say is that I hope they aren’t Buddhists because the Buddha wouldn’t approve and neither would Thich Nhat Hanh or the Dalai Lama. Mahayana, Theravada – doesn’t matter. The Buddhist community would simply tell them that anger causes them to think irrationally and to suffer; that mindfulness is critical to taking good care of their anger and that they must transform their anger into compassion. Right thinking does not come from anger. Because I’ve said this, now these individuals will claim that I’m wrong about Buddhism just so they can be right about that too and justify their anger. I’m not wrong. I was a Buddhist for many years. At one point, I even contemplated becoming a monk. No points for them this round either. Time for a retreat to Plum Village, angry Buddha because you need a refresher course in the twelve turnings of the dharma wheel. Maybe if you did that, then you’d develop some samyak samadhi and enough samyak pradhana to listen to and learn from my dharma talks concerning MMT. Then you could attain prajnaparamita with regard to macro.

And speaking of religion, as to the latter case, the reality is that mainstream economics, which forms the foundation of their false beliefs, is all opinion precisely because it is nothing more than religious mysticism. The orthodoxy does not seek to understand how the macroeconomy actually works. They merely want the economy to work the way that they want it to work, then they set out to create models that confirm their delusions. The result is utter chaos and total nonsense masquerading as ‘professionalism’, ‘academic achievement’, and ‘scientific rigor’.

I call it the stupid circus.

New Keynesian Ringleader: “Step right up, folks! Step right up and watch as Mr. Intermediaries brings savers and investors together through the sheer power of his imagination. Ladies and Gentlemen, thrill to the prognosticating powers of Mr. DSGE as he predicts future economic results with stunning accuracy through the use of a model that assumes only one person in the economy and on top of that, the economy has no money in it! Stand in awe of Mr. Flip-Flop as he skillfully contradicts himself concerning the necessity of microfoundations with the greatest of ease and then claims that he’s always been right about everything! Witness the grand finale as our escape act duo, The Ad Hoc Brothers, free themselves from all responsibility for failing to see the global financial crisis coming by resorting to ex post rational, convenient excuses, and repetitive statements of “Nothing to do with us!” Yes, folks, by the time the show’s all over, you too will believe that the trade imbalance between China and the US must be fixed or else in the long run the dollar will collapse, and that the Earth is a black and white checkered tuna fish with four wheels and is shaped like a trapezoid. Step right up!”

‘Nuff said there, I think. But back to these angry, ‘appeal to emotion’, macroeconomic so-called ‘Buddhas’.

I speak from a position of clear logic and reason, unencumbered by the uselessness of anger. That logic and reason is the result of careful analysis: how currency enters the economy, how it flows through it, and how it exits the economy, the real resources each nation has at its disposal, and their relationship to both domestic economies and international trade. Put simply, I do get angry at things, but when it comes to how the monetary system and macroeconomies work, I don’t apply my anger. I set it aside. I don’t speculate, I don’t guess, I don’t imagine, I don’t set out to fudge data so that it confirms my beliefs allowing me to justify my anger. As my friend, Steven Hail would say, “Respect the data.” I respect the data.

Taking the scientific approach, which removes politics from the analysis and the explanation, makes me a stupid, worthless, no good, goddamn son of a bitch, retarded, big mouth, know-it-all, asshole, jerk precisely because the approach leaves no room for opinion and, thus, it strips these people of their self-decreed intellectual status with regard to the subject matter. The belief that MMT is all just opinion is what allows them to claim such an elevated status. As long as politics is in play, these people can be macroeconomic ‘experts’ and they can speak with great authority on the subject. Just try and imagine:

Mechanic: “If you do not change the oil in your car, the engine will be seriously damaged.”

Angry Political Person: “Stupid, worthless, no good, goddamn son of a bitch, retarded, big mouth, know-it-all, asshole, jerk.”

Makes no sense, and the reason why it doesn’t is because automotive mechanics isn’t intertwined with politics – not yet, at least. Considering these peoples’ belief that they know everything about everything without putting in the effort to actually learn anything, it’s possible that such a thing could happen in the future.

Mechanic: “If you do not change the oil in your car, the engine will be seriously damaged.”

Angry Political Person: “There’s more to it than that, but whatever. There are many different schools of thought on this subject, each with differing opinions. The fact is that oil never completely goes away. It always remains in the car even if you drive 80,000 miles without ever changing it. You can get insight into this fact by just unplugging the drain on the oil pan of a car that’s gone 80,000 miles without an oil change. What comes out? Oil. Duh. So, a failure to change your oil isn’t what will lead to engine damage. What causes engine damage is foreign nations propping up our economy with their cheap cars that have engines designed to fail after so many miles. They do that so we are forced to keep buying more and more of their cheap cars. Some of these nations are now entering the post-industrial phase, they no longer need us, and they’re going around convincing other nations to rebel against the dollar. The IMF recently made this particular nation’s currency a reserve currency, so other nations are attracted to it thinking it’s great and they want to shift their investments to this particular nation and away from us. By 2050, the US could resemble something from an episode of ‘Life After People”. So, these foreign nations propping up our economy with their cheap cars that have engines designed to fail is a potential catalyst for a serious devaluation of the dollar. But that’s just speculation on my part.”

Maître d’: “I weep for the future!”

Me: “Excuse me, Maître d? Check please. I can’t take the nonsense any more.“

Speaking of nonsense, that reminds me. I almost forgot about the reason why I am writing this article. That’s how very unimportant the so-called ‘trade imbalance’ between the US and China really is – there is no trade imbalance. So, I guess this brings me to the thing that I’m about to do which I hate doing. I’m going to use tadpoles as an example to explain why these people are wrong about trade imbalances and international trade.

Let’s say that I show you a picture of a particular animal’s tail only and the tail is clearly underwater. Then I ask you to tell me what kind of animal it might be including various details concerning the animal’s lifespan, behaviour, etc. From this very limited picture, the chances of you figuring out what kind of animal it is is pretty low, much less accurately knowing its lifespan, describing its behaviour, etc.

The reason why should be obvious.

An underwater picture of its tail isn’t enough information for you to go on. At this point, all you can do is speculate. and if you are going to give me an immediate answer, then speculate is what you will do.

There are potentially thousands of possible animals and explanations. We will assume that you forego a land-based animal that merely happens to have its tail in the water, so it must be some kind of fish. You look very closely at the picture for several minutes, and then suddenly it hits you: It’s a stingray because you recognise the tail. But you do not stop there. You’ve been to college, you’ve studied biology, and it just so happens that you know quite a lot about fish, both freshwater and saltwater, and you also like to impress everyone with your deep knowledge of the subject. So, you tell me that this particular type of stingray is a freshwater ray known as Potamotrygon.

 

Fig. 1. Potamotrygon

Photo Credit: Jim Capaldi 

 

Wow! That’s a big, scientific name there. Never heard of that before. And so, you are certain that this is the animal in question?

“Oh, absolutely.”

I am impressed. I do not know how you figured that out.

“I’m very knowledgeable about this subject.”

Tell me all about this particular stingray. It is sure to be fascinating. So, you begin to lecture me on the subject with great authority:

“Well, you see, Ellis, Potamotrygon is a freshwater stingray native to South America. It is a carnivorous bottom-feeder.”

Really? Tell me more.

“Well, like any stingray, it is very dangerous to humans because of the tail. The tail has a barb that secretes venom.”

Geez. Sounds scary. Wouldn’t want to step on one then. How big do they grow?

“Oh, about one foot to five feet in length.”

So, not a big as a manta ray then.

“No, but still very much poisonous and dangerous if you get stung.”

Anything else you can tell me?

“People are known to keep them in aquariums. There is a certain demand for this particular genus of stingray. In fact, most rays found in home freshwater aquariums are Potamotrygon. Since Potamotrygon is quite sensitive to its environment, extreme filtration is necessary for its survival. Keeping them can be quite expensive and tedious. So, the majority of aquarium owners who possess them view their aquariums as much more than mere hobbies or conversation pieces. You have to know quite a lot about the subject.”

Like you.

“Well, I don’t own an aquarium, but yes. I know a lot about the subject. I studied it in college.”

Tell me a little more about this barbed tail and how it’s dangerous to humans.

“Ok, so, common people believe that stingrays aren’t harmful to humans, but this is a myth. They are very much dangerous. The barb has flat spines, composed of a tough, cartilaginous material which slices through human flesh like a hot knife through butter. The material contains venom-secreting cells that inject venom when the barb penetrates flesh.”

Uh-huh. Go on.

“Stingray venom causes nausea, vomiting, diarrhea, extreme pain at the wound, and muscle cramps. There have been cases of amputations and death.”

Scary. Well, this certainly was quite an informative lecture.

“Thank you.”

But you are completely wrong.

“Uh, no, I don’t think so.”

But you are wrong. The animal in the picture is a tadpole.

 

Fig 2. Tadpoles

 

The problem now is made obvious. Without enough information to go on, our knowledgeable self-appointed ‘expert’ had to resort to speculation to fill the information gap. Stingrays and his knowledge of them have no application here. If we then follow his logic to its absurd conclusion, we will never arrive at the reality that the animal in the picture will one day become a frog and a frog doesn’t have a barbed tail. Clearly, any discussion concerning the stingray will only lead to total nonsense. Consider the end result:

“A tadpole is a carnivorous bottom-feeder. It is very dangerous to humans because of the tail. The tail has a barb that secretes venom. Many victims of tadpole related injuries suffer from nausea, vomiting, diarrhea, and muscle cramps, and in some cases even amputations and death.”

Abject nonsense.

Claiming that China is lending money to the broke US government, that the national debt is crippling, that China could call in the debt destroying the US economy, and that a trade imbalance exist which we must fix immediately, is the same thing as telling everyone that a harmless tadpole is actually a stingray and then carrying on about the dangers of stingray venom and stings to human beings. Understand?

As a side note, this is precisely how conspiracy theories are created.

A person with limited knowledge of a complex subject fills in the missing details (the knowledge gap) with ‘connect-the-dots’ speculation which is easy for the person to understand, rather than putting forth the effort to actually learn the complex details. And with regard to the monetary system, macroeconomics, international trade, treasury bond purchases, and the United States’ non-existent ‘trade imbalance’ with China, our self-appointed ‘expert’ applies enormous amounts of speculation to fill his knowledge gap which eventually leads him to conclude that the market is in charge of the economy and jobs, the US government is borrowing dollars from China at a furious pace, the national debt is out of control, China is now propping up the US economy because businesses have fled the US to manufacture goods cheaper in foreign countries, and that in the long run, the dollar will devalue and we will all die. Had he possessed enough factual basic information, he would have known that there is no trade imbalance nor is there any serious problem, now or long term, with China holding bonds.

How Things Actually Work

The truth is that every single US dollar in existence came from federal spending. The US government creates US dollars every time it spends. When you begin from this premise – which is actual reality by the way – you are then in a position to understand what is really going on. And what is really going on is uneventful and quite boring. China doesn’t issue dollars, so it must earn them. It earns them the same way Apple earns US dollars: It produces goods and then sells them to US customers.

As to the US government issuing treasury bonds, since the government is the dollar issuer, it doesn’t need to borrow its own currency. There must be another reason then for why it issues bonds, and there is.

Careful analysis demonstrates that the US government manages the domestic economy through monetary policy, not fiscal policy. Monetary policy is the setting of the price of bank lending. The Federal Reserve conducts monetary policy by setting a target interest rate. The Fed must defend any rate that is positive. It uses treasury bonds to defend that rate. The Federal Reserve obtains bonds through open market operations. There are other means too such as paying interest on reserves. Competition between banks for excess reserves will push down the overnight rate threatening the target rate. The Federal Reserve then goes into reserve accounts, removes the excess reserves and replaces them with a treasury bond. This halts the competition for excess reserves and so the target rate is defended. This means, quite clearly, that treasury bonds conduct monetary policy, not fiscal policy. So, the US government issues treasury bonds for the purpose of establishing and maintaining a particular interest rate. It doesn’t even need to do this, because paying interest on reserves has the same effect as bonds do: It prevents the overnight rate from falling which would threaten the target interest rate. In fact, the federal government doesn’t even need to issue bonds or pay interest on reserves. It could order the Federal Reserve to maintain a zero interest rate policy and stop issuing bonds. As long as the target rate is zero, there is nothing to defend. Treasury bonds are an anachronism, pure and simple.

Since entities bid on bonds and since the US government only accepts US dollars for treasury bonds, bonds also act as savings accounts that pay interest. This is precisely why China holds US treasury bonds – to stick their earned dollars into savings that earns a bit of interest. The act is no different than what you do with your earned US dollars, or what a corporation like Apple does with its earned US dollars.

Settlement payments on successful treasury bond bids are concluded when the Federal Reserve shifts dollars held in reserve accounts to accounts called ‘securities accounts’. Both reserve and securities accounts are held at the Federal Reserve. The act reduces available US dollars in the economy. Another way of looking at this is that when the Federal Reserve shifts reserve balances to securities accounts, it temporarily deactivates those dollars making them unspendable because they are locked away. The US government doesn’t spend them, and nobody in the non-government sector can either. What were once active, spendable dollars are now deactivated until the Federal Reserve shifts those dollars back to reserve accounts upon maturity, thus reactivating the dollars.

When China earns US dollars it can only do a limited few certain things. 1.) It can leave the dollars in a reserve account at the Federal Reserve. 2.) It can bid on treasury bonds, sticking its earned dollars in savings accounts to earn interest. 3.) It can spend the dollars in the US or wherever US dollars are accepted as payment for something. 4.) It can convert the dollars to another currency at its own expense. Giving China all of its dollars back simply means that the Federal Reserve shifted dollars held in securities accounts back to reserve accounts. China can choose to either spend them in the US opening factories creating jobs for Americans, or buying goods and services which will add some jobs, or it can do nothing, or it can place them back in savings by bidding on bonds, or it can exchange them for, say, Euros, and enter the European market. So, what do we understand thus far, and what insights can be gained through that understanding?

1.) There is no actual debt in the household sense of the word for the US government because all dollars used to buy treasury bonds first came from federal spending.

2.) The national debt is all US dollars in existence minus all US dollars that the US government ever taxed. This is verified when we add up all cash and coin, reserve balances, and securities account balances. The total equals, to the penny, the national debt.

3.) There is no actual lending going on. China isn’t ‘loaning’ the US government some ‘money’. It’s earning the US government’s own currency (US dollars), and then saving them in an account which is also provided by the US government (treasury bonds).

4.) China is ‘paid off’, not through increased taxation, but by simply shifting dollars held in a securities account back to a reserve account. No different than you shifting dollars from savings to checking.

5.) Nothing that China does with US dollars, or with its own currency, or economy, nor anything that the IMF says, nor the fact that the IMF declares China’s currency to be a reserve currency will ever prevent the US government from spending, nor from achieving full employment and ensuring the public purpose through that spending. The world’s opinion of the US dollar has no bearing on whether or not the federal government can spend its own currency into existence to address domestic economic issues. If foreign nations do not wish to export to the US, then the US government will simply spend for production at home. It will spend to utilise all of the idle real resources in the US, reopening factories, and Americans will consume their own production. The market does not control jobs or production; the US government does through net spending.

Lastly, what about this non-existent trade imbalance? There isn’t one. And once again, to understand why, you need deeper knowledge of certain relevant concepts.

The Current Account (The Transaction of Goods)

Using the US as our example, the current account reflects the foreign goods that the US has imported priced in US dollars. Since the mid 1980’s, the United States has imported foreign goods from around the world more than it has exported US goods to the rest of the world. The technical term for the condition where one nation imports more than it is exporting is called a ‘current account deficit’, because there are more goods coming in than going out. Hence, a deficit of traded goods for one nation exists relative to the trading partner. Thus, when what the US exports is less than what the US imports, a current account deficit exists.

The Capital Account (Financial Transactions)

The US must pay for the foreign goods that it imports, and those purchases are reflected in what is called the ‘capital account’. The capital account reflects US dollars held by the rest of the world outside of the United States. A ‘capital account surplus’ exists when the US buys imports more than it sells exports. It just means that the rest of the world is choosing to save in US dollars by selling their production to the US. So, the current account reflects the transactions of goods and the capital account reflects the financial transactions. In other words:

Current Account: Foreign goods priced in US dollars

Capital Account: US dollars spent to purchase foreign goods.

The US must pay for the foreign goods that it imports. If China has $ 3 trillion, then it just means that the US has $3 trillion worth of Chinese goods. Or are you forgetting that the US actually takes possession of the goods? Do you actually think that it just hands over dollars without getting anything in return? So, the current account deficit is matched, dollar for dollar, with a capital account surplus. As an example, let us assume that the US imported, say, $6 billion worth of foreign goods in total from all nations:

$6 billion worth of the rest of the world’s goods – $6 billion to buy the rest of the world’s goods = 0

The US gets $6 billion worth of goods and the rest of the world gets the six billion dollars that were spent to buy the goods.

There is no such thing as a ‘trade imbalance’.

Imports are benefits because they raise the standard of living for US citizens. US citizens consume whatever the US produces for themselves and on top of that, US citizens get to consume the production of other nations too. China is employing its own labour and its own real resources which the US doesn’t own, then its producing goods which its own people could consume for themselves. But instead, it is selling that production off to US citizens for them to enjoy and all that it gets in return is a bank statement from the Federal Reserve denominated in a currency that China doesn’t issue and in a currency that China can only do limited things with.

When you do not have enough basic information or the correct information regarding how the monetary system works, nor a sufficient understanding of concepts such as the current account and capital account, you simply cannot understand US trade with China, how it works, why China acquires US treasuries, what happens to the dollars, what the ‘debt’ actually is, and what this activity means for the US economy. You have but a very limited picture and you simply cannot know. All you can do is speculate.

So, some well-meaning people who believe themselves to be well-informed and intelligent when it comes to macroeconomics and international trade simply because they follow politics, will now call me a stupid, worthless, no good, goddamn son of a bitch, retarded, big mouth, know-it-all, asshole, jerk.

I’m sorry they feel that way. It happens. They are as mistaken about me as they are MMT and macroeconomics.

Tadpoles are at the beginning stages of what will soon become a mature adult frog. People who have absolutely no background in the monetary system and macroeconomics, and those who possess incomplete or errant information, are tadpoles. I do not mean this in a demeaning sense whatsoever. All I am simply saying is that their knowledge of the subject matter isn’t mature and I’m trying to get that across to these individuals through visual illustration. When it comes to automotive mechanics, I’m a tadpole. When it comes to medicine, I’m a tadpole. When it comes to MMT and macroeconomics, I’m not a tadpole. So what?

So, my recommendation to economic tadpoles is don’t pretend to be a frog when you aren’t one just yet. You have it in you to become a frog one day, but that day isn’t here yet. Enjoy the time spent educating yourself and the learning experience.

You need time to develop and that development might not be easy. There’s a lot to this subject that is complex and confusing. But there is help everywhere you look. I teach MMT and I am telling you that you can do this if you only put your mind to it and employ some diligence. You can do this. You should learn and understand basic, fundamental concepts of MMT first, no matter how difficult it might seem, because those concepts describe reality, unlike the concepts you’ve learned from friends, family, politicians, social media personalities and orthodox economists. Take lots of time to learn the fundamentals. That way, your knowledge and your understanding of real world economics will mature.

Tadpoles don’t speak; frogs do. Wait until your understanding matures, then you will be able to speak with authority on the subject.

That’s all I have for today. Thank you.