One of the best decisions I made in the early 1990s was to get Herb Stein to do a piece on the balance of payments for The Concise Encyclopedia of Economics, which was then The Fortune Encyclopedia of Economics. His first two paragraphs are still beautiful:
Few subjects in economics have caused so much confusion—and so much groundless fear—in the past four hundred years as the thought that a country might have a deficit in its balance of payments. This fear is groundless for two reasons: (1) there never is a deficit, and (2) it would not necessarily hurt anything if there was one.
The balance-of-payments accounts of a country record the payments and receipts of the residents of the country in their transactions with residents of other countries. If all transactions are included, the payments and receipts of each country are, and must be, equal. Any apparent inequality simply leaves one country acquiring assets in the others. For example, if Americans buy automobiles from Japan, and have no other transactions with Japan, the Japanese must end up holding dollars, which they may hold in the form of bank deposits in the United States or in some other U.S. investment. The payments Americans make to Japan for automobiles are balanced by the payments Japanese make to U.S. individuals and institutions, including banks, for the acquisition of dollar assets. Put another way, Japan sold the United States automobiles, and the United States sold Japan dollars or dollar-denominated assets such as treasury bills and New York office buildings.
Herb died in 1999 and so, when I did the second edition of the Encyclopedia earlier this century, I, with the help of Kevin Hoover and the late Mack Ott, updated his numbers and added the last two paragraphs:
These same concerns surfaced again in the late 1990s and early 2000s as the current account went from a surplus of $4 billion in 1991 to a deficit of $666 billion in 2004. The increase in the current account deficit account, just as in the 1980s, was accompanied by an almost equal increase in the deficit in goods. Interestingly, the current account surpluses of 1981 and 1991 both occurred in the midst of a U.S. recession, and the large deficits occurred during U.S. economic expansions. This makes sense because U.S. imports are highly sensitive to U.S. economic conditions, falling more than proportionally when U.S. GDP falls and rising more than proportionally when U.S. GDP rises. Just as in the 1980s, U.S. employment expanded, with the U.S. economy adding more than twenty-one million jobs between 1991 and 2004. Also, employment as a percentage of population rose from 61.7 percent in 1991 to 64.4 percent in 2000 and, although it fell to 62.3 percent in 2004, was still modestly above its 1991 level.
How about the issue of foreign ownership? By the end of 2003, Americans owned assets abroad valued at market prices of $7.86 trillion, while foreigners owned U.S. assets valued at market prices of $10.52 trillion. The net international investment position of the United States, therefore, was $2.66 trillion. This was only 8.5 percent of the U.S. capital stock.
By the way, Herb was my boss at the Council of Economic Advisers in the summer of 1973, when I was a summer intern fresh off my first year as a Ph.D. student at UCLA. He was one of the two best bosses I ever had. (The other was Bill Meckling, dean of the Graduate School of Management at the University of Rochester.)
READER COMMENTS
Craig
Mar 7 2025 at 12:59pm
“The balance-of-payments accounts of a country record the payments and receipts of the residents of the country in their transactions with residents of other countries. If all transactions are included, the payments and receipts of each country are, and must be, equal. Any apparent inequality simply leaves one country acquiring assets in the others.” <–first rate and easily understood, I wonder if, when I learned this concept back in the day if I might not have read this excerpt then. Have a vague recollection and often my memory fails as to specifics from decades ago (ie transfer payments not being part of GDP).
Chris Gardner
Mar 8 2025 at 7:15am
While the current and financial account will balance, are there disadvantages in the US buying consumer goods from foreign countries and those foreign countries with a trade surplus buying US stocks and US real estate?
Thomas L Hutcheson
Mar 9 2025 at 2:53pm
The way fiscal deficits work post Clinton — borrow money to cut taxes — trade deficits/capital inflows are the reflection of “too low” national savings, so they are a refelection of something wrong, but not bad in themselves.
Warren Platts
Mar 8 2025 at 2:54pm
After 20 years, it’s time for another update: NIIP is $24 trillion as of Q3 2024. This is 80% of GDP. Historically, bad things tend to start happening when a country’s NIIP gets below 60%. Maybe the USA is special?
https://fred.stlouisfed.org/graph/fredgraph.png?g=1EhRL&height=490
Warren Platts
Mar 8 2025 at 3:02pm
I should add that 1991 current account surplus was because of the Gulf War when the Saudis and Gulf Arabs paid us billions and billions to do their fighting for them…
David Henderson
Mar 8 2025 at 5:24pm
Thanks, Warren.
Jon Murphy
Mar 8 2025 at 3:30pm
Shades of Adam Smith with that opening line from Stein. (I’m referring to Smith’s comment that the trade balance as a concept is “absurd”)
David Henderson
Mar 8 2025 at 5:24pm
Yes. Good point.
Warren Platts
Mar 9 2025 at 1:06am
Let’s try to unpack this a little bit. Yes, there’s never a deficit in the sense that we export assets (instead of exports) to pay for our imports. But, technically, we still have a current account. It runs a deficit. Thus I’m a bit leary when Mr. Stein says a current account deficit would not necessarily hurt. That statement, however, logically implies that maybe, just possibly, a current account deficit could (eventually? after 80 years? 100 years?) hurt. If so, what do you all propose we do about it? If nothing, then what will the eventual unwinding be like?
Jon Murphy
Mar 9 2025 at 8:16am
No. The word “necessarily” excludes the possibility you mention. Stein’s point, made explicitly, is that the trade deficit does not imply harm.
Rather, if something harmful is happening, it could be reflected in a trade deficit (eg a government running low on hard currency and having to borrow heavily). But, in that case, the trade deficit is a symptom, not a cause of the harm.
To use another example, a sneeze is not necessarily harmful. That doesn’t imply that a sneeze could kill you. Some underlying disease that causes sneezing could kill you. But the sneeze is merely a symptom.
Warren Platts
Mar 9 2025 at 3:05pm
Jon, you need to brush up on your modal logic! ~□p means the same as ◊p. Herb didn’t say necessarily: he said not necessarily. That’s the same as saying possibly.
Your sneezing analogy is interesting (sneezing is usually considered a symptom, but it could kill if it caused an aneurism to rupture, for example). The main thing is if there’s a problem, it needs to be fixed. I will grant that if there’s a chronic, going on a century, current account deficit that’s indicative of a problem, then whether it’s a symptom or a cause is important to know, to be sure. But the main concern is what the heck to do about it. If the answer is nothing, that’s a legit answer (if you’re on a rocket getting launched & lightning strikes & lights & alarms start going off everywhere, doing nothing is the default tactic). Fair enough. But I ask again, what is the eventual unwinding going to be like under that strategy…
Jon Murphy
Mar 9 2025 at 4:13pm
No.
Again, that’s confusing two things. The sneeze didn’t kill. The aneurysm did. Failure to keep causes of events seperate from coincidences leads to much confusion, thus Stein’s comment.
Jon Murphy
Mar 9 2025 at 4:14pm
You say “grant” when you should say “assume.” The whole point is that trade deficits are not a problem, no matter how long they persist.
Warren Platts
Mar 9 2025 at 4:23pm
I repeat: ~□p means the same as ◊p.
Warren Platts
Mar 9 2025 at 5:20pm
And this reminds me of something I think Dostoevsky said, something to the effect that “Everybody is responsible for Everything…”
and
Mar 9 2025 at 12:43pm
By chance, I met Herb Stein on an elevator at the Hilton Hotel in NYC at an AEA meeting some time in the early 1970’s. We were alone together and I asked him about the health of Milton Friedman, who recently had some kind of heart surgery. He assured me that “Milton would be around for a long time. Don’t worry.” Or words to that effect. He was a charming and friendly guy. And, he was right.
David Henderson
Mar 10 2025 at 7:49pm
He was charming and friendly.
I remember that year. Milton had his heart surgery in late 1972. He recovered in Palm Springs. My professor Armen Alchian, a scratch golfer, lent Milton a putter so he could fill his time while recovering. I think Armen said he didn’t use it.