Why must a balance of payments between nations be achieved? (capitalism, debt)

[Libohove90]

I am guessing because if your currency is held by foreigners, somehow that currency must make its way back to the importing nation where its used. Or else, currency held by the exporting nation will simply be lost and the importing nation experiences a decrease in the money supply because the exporting nation does not want to buy any assets from the importing nation.

Am I right? Is this why balance of payments is important among nations?

[wawaweewa]

Originally Posted by Libohove90

I am guessing because if your currency is held by foreigners, somehow that currency must make its way back to the importing nation where its used. Or else, currency held by the exporting nation will simply be lost and the importing nation experiences a decrease in the money supply because the exporting nation does not want to buy any assets from the importing nation.

Am I right? Is this why balance of payments is important among nations?

Because currency wars ensue which lead to global instability. Nations that do not wish to get involved are forced too because currency wars are usually fought by economic powers.
Sometimes that instability can be worked out ala the and 70's and 80's via the Plaza Accord and the Smithsonian agreement. Other times, currency wars foster all out armed conflict.

[Libohove90]

Originally Posted by wawaweewa

Because currency wars ensue which leads to instability. Sometimes that instability can be worked out ala the and 70's and 80's via the Plaza Accord and the Smithsonian agreement. Other times, currency wars foster all out armed conflict.

So I am right. The exporting nation must do something with the currency held, or else it will hurt the importing nation by decreasing its money supply. This is the currency war you are talking about?

[Philip T]

Things are a little deeper than this.

First, the US is an uneven playa in an uneven game.

We print THE reserve currency and declare anyone who says different a terrorista and bomb and kill them. So the general rules you describe do not really apply to US. At least not yet. Such is Empire.

But back towards a more even world -- as trade goes back and forth, some have accumulation of wealth and grow richer. And of course some go into debt and grow poorer. So in the end this will have a crash if it goes too far out of balance.

The "Greater Good" concept is that there is supposed a "Comparative Advantage" for various trade from various sources -- e.g. a tropical location may grow bananas. A cold climate may raise sheep and produce wool. Once all the trade goes round-and-round everyone is supposed to come out ahead.

In practice -- Comparative Advantage theory is Total BS.

What tends to happen instead is Mercantilism Behavior followed by Wars.

Balanced trade -- back to your start -- would prevent US from pretending Empire, and also stop China, et al, from their present Mercantilism path.

Well managed Tariffs can help balance trade.

[pvande55]

China is keeping its currency under valued and nobody has the guts to do anything about it. In fact Romney is the only candidate talking about it. On the other hand, the Euro may be overvalued.

[Libohove90]

Originally Posted by pvande55

China is keeping its currency under valued and nobody has the guts to do anything about it. In fact Romney is the only candidate talking about it. On the other hand, the Euro may be overvalued.

True, but that doesn't answer my question. The balance of payments between US and China is achieved because the Chinese government is using our currency to buy dollar-denominated assets. But I am referring to a situation where the exporting nation does not use that currency to buy assets in the importing nation. What happens to the importing nation? Does its money supply decrease?

[wawaweewa]

Originally Posted by Libohove90

So I am right. The exporting nation must do something with the currency held, or else it will hurt the importing nation by decreasing its money supply. This is the currency war you are talking about?

Yes, this is a component.

In fact, one of the major problems with our trade deficit with China was that China was exporting deflation to the US.

Although in this case, a nation printing its own currency can simply start to tighten the trade deficit by increasing the money supply. The problem with China is that their currency is pegged to the USD. If we increase the money supply by 1 trillion USD, China has to increase it by the same amount in yuan. The balance of trade doesn't change. All it does is export inflation to China which can and did force China to strengthen its currency because inflation was starting to hurt politically.

[Philip T]

Originally Posted by Libohove90

But I am referring to a situation where the exporting nation does not use that currency to buy assets in the importing nation. What happens to the importing nation? Does its money supply decrease?

ahhh, that is much simpler.

In theory what you say could be so. And if so that would be deflationary.

However, in practice, generally the country just prints more. And that would be inflationary. Eventually no one wants the currency. See Zimbabwe for an example of the extreme.

[Libohove90]

You guys are awesome. City-Data is full of really smart people, and perhaps America does have a lot of intelligent people underneath the surface. Thanks for clearing it up. Now I have to get back to reading Capitalism and Freedom. The chapter on International Trade Arrangements was terribly confusing.

[Libohove90]

Originally Posted by Philip T

ahhh, that is much simpler.

In theory what you say could be so. And if so that would be deflationary.

However, in practice, generally the country just prints more. And that would be inflationary. Eventually no one wants the currency. See Zimbabwe for an example of the extreme.

So I guess Zimbabwe had a balance of payment problem? I mean after all, who the hell would buy anything in Zimbabwe? Is this a reason why Zimbabwe started printing money to balance its payments and thus experienced unbelievable inflation?