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Laffer on the Trade Deficit

Laffer on the Trade Deficit

In the 1980’s Arthur Laffer gained fame by sketching his controversial “Laffer Curve” on a cocktail napkin. In an interview today on CNBC Mr. Laffer lead me to believe that the same napkin could probably provide enough surface area to hold the sum total of his economic wisdom. In a stunning display of economic ignorance and media propaganda, Laffer not only explained why the gargantuan U.S. trade deficit was not a problem, but argued that an even bigger one would be even better. Come again?

In an attempt to explain why such deficits can exist indefinitely, Laffer compared today’s current account deficits to those seen during America’s first two hundred as a developing nation. This flawed comparison over looks the fact that as a developing nation, America borrowed to invest, resulting in current account deficits that funded the construction of vast infrastructure, such as roads, bridges, ports, and rail roads, as well the formation of capital equipment, farms, and factories, all of which fueled American productivity. Such investments enabled the production of vast quantities of consumer goods, which America sold back to its creditors, to both pay interest and retire principle. In the end, America’s creditors got consumer goods, and America became the wealthiest industrial nation the world had ever seen, in the process turning its current account deficits into enormous surpluses.

In a “night and day??? contrast, today’s current account deficit has the much more limited role of solely financing consumer spending. By squandering borrowed money on consumption, America has no way to repay the principal of its debts, let alone the interest. Borrowing to built a factory is not the economic equivalent of borrowing to buy a television set, and its amazing that Laffer can’t see the difference.

Second, Laffer defends the trade deficits as resulting from the vastly superior investment returns available in America. His argument is that a capital account surplus necessitated a current account deficit. Talk about putting the cart before the horse. According to Lafferese, foreigners sell products to Americans to earn dollars, so that they can “invest” in America to achieve superior returns. This ridiculous logic overlooks the fact that much of these earrings are simply invested in low yielding government and corporate bonds, with a significant portion being purchased by foreign governments. If as Laffer maintains, investment returns in the U.S. really were far superior to those available else where, why are foreign central banks doing so much of the “investing?” Where is all the private capital seeking those alleged superior returns?

Lastly, when asked if a six hundred billion dollar trade deficit was a good thing, wouldn’t a one trillion dollar deficit be even better, Laffer’s round about response was basically, yes, the bigger the better.

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