Free Trade. Voluntary exchange..something all human being engage. This is no exception. The biggest misconceptions is that trade is a zero sum game. This is false. Trade is simply an exchange, as both parties are seeking to obtain “happiness”. Both parties benefit from engaging in voluntary exchange.
Trade is not equal
When two parties engage in a transaction, the respective parties have different valuations on the goods exchanged. Suppose I am seeking a case for my iPad Pro: What happens? For starters, I review the various items, in the Apple store, and compare prices. Why am I comparing prices? Perhaps I have a budget, and I must consider the other items. I have scarcity: I must purchase the iPad Pro with my limited stack of cash. As I review the inventory of iPad accessories, I locate the case: $49.99 plus tax.
I go to check out register, I provide the cash for the iPad case. The cashier rings up the order, bags up my item, and I walk out of the store. The store values the cash, $49.99 plus tax, more than they value the iPad Pro case. They need my money in order to purchase more inventory, cover its fixed and variable cost associated with the business operation. On the other hand, I value the iPad case over the $49.99 plus tax I paid for the accessory. Both parties value the items, in the trade, differently.
Trade is equal…it balances(?)
Before going into a simple analysis on how trade is equal and it balances, another concept must be introduced: Money/Currency. Money is utilized as an intermediary in the voluntary exchange, since the process of barter, is quite clumsy and inefficient. Why would the Apple store take two cows for an iPad accessory? They are in the electronics business, not the farming business. Money simply holds value, acts as a financial intermediary, and it acts as a score keeper. Prices are typically expressed in terms of money.
Although the valuation of the respective “goods” differ (The need for the iPad by the buyer, the need for the money by the seller), the accounting is equal or it balances. On the Apple store’s books, they will realize an increase in cash, but a decrease in their inventory of iPad accessories. Those entries shall equal based upon the transaction price. Note: This analysis is not going to go through all the GAAP details needed to make proper bookkeeping of the transaction, just the cursory journal entries are covered here. The buyer has a decrease his cash balance, but he increases his goods inventory by one iPad accessory. The trade balances. Of course, we can account for this balance expressing the transactions in terms of the money used.
But is there a Trade Deficit?
Suppose I compare how many iPads I purchase from the Apple store versus how many iPads the Apple store purchases from me? Using this sort of analysis would yield a deficit. However, I am not in the business of selling iPads to the Apple store. The Apple store already sells iPads—why would they need to purchase iPads from me, yet they are attempting to sell them for cash? When Government economists are analyzing the “trade deficit”, this is the basis of their analysis. This sort of analysis does not include the subjective value of the parties involved in the trade, nor does it account for the varying goods, services, talents, and skills have—and the things that the other party desires or values. If a person is comparing the exact same items that both parties should purchase from each other, it will show a “trade deficit”, but this notion makes no economic sense.
All of us are born with a certain set of skills, talents and abilities. As we mature, if we identify these talents, and develop them, we enter the marketplace to promote them. For example, if I am an aspiring musician, and I want to showcase my talent, I will sell my time to perform a concert for others. When I perform this concert, I would be compensated, with money, for my efforts. In this case, I value the money being paid, over the time spent perform the music. I am not seeking to trade music for music…again that is nonsensical, for the reasons previously mentioned. I am seeking to obtain the money to payback some of the expenses related to musical development, and to continue the promotion of my talent. Oh , yes, I would need to eat, sleep, bathe, and those sort of trivial matters.
Since the fundamental condition of human behavior is to “seek happiness”, I shall use my talents and gifts to engage in voluntary exchange to obtain happiness. The notion of comparative advantage is all about what skills I have compared to the other party in the trade; both parties can benefit via the trade with each other. Neither party will have the exact same skill, nor will either party value their skills equally, as they want what the other party is offering in the trade.
The Missing Part in Trade Analysis
While there are growing concerns regarding the trade deficit, people are pushing to “balance” the trade. Yet, trade is balanced. It is balanced for every single individual transaction, on the micro level, and it is balanced at the macro level. What is still causing the concern of a trade deficit? The analysis of comparing how many goods one party purchases from another party is the main issue in this analysis. Stated differently, using our example, the concern is that the Apple Store is not purchasing the same amount of goods from me, as compared the same amount of goods I purchase from the Apple Store. On the surface, this seems plausible, but it is not. There is another part missing in this analysis: The money.
If money is analyzed as a “good”, then it is simpler to understand that there is no trade deficit. For example, a firm in another country, produces the ZPad. I go online to purchase the ZPad. The exchange follows the pattern as previously mentioned, and to complete the transaction, I pay for the item with US Dollars. This firm, located in another country, is glad to receive my money. At the time of this writing, the US Dollar currently is the reserve currency, this foreign firm values my dollar over his currency and the product he is selling. The US Dollar allows him to pick up more items, in his native nation, more cheaply, which allows him to purchase more inventory to sell. At the macro level, this sort of activity increases the capital base, as the banks, and other financial institutions, and accumulate more US dollars to develop, loan out, and build the local economy in that nation.
Eventually, those US dollars make their way back “home” to the United States. Those foreign banks will invest into US assets, i.e. US Government Treasury Bills, Real Estate, and other assets located in the United States. As those assets are purchased, those US dollars are deposited into banks based in the United States. It all balances, and it actually comes “full circle”.
There is no such thing as a “trade deficit” in voluntary exchange. There is not a zero sum transaction when trade occurs. Both parties benefit from trade despite the fact that both parties value their respective goods differently. And, if there are concerns about if the trade “balances”, always follow the money.