Aid vs. Trade

September 11, 1961

Two recent actions by the Administration emphasize the deep confusion that exists about the causes and cure of the “deficit” in our balance of payments. One was the announcement that the United States would shift from European to domestic producers for the coal and coke it needs to supply its forces in West Germany. The other was the reduction in the duty-free allowance of Americans returning from abroad from $500 worth of goods each to only $100 worth. Both actions were taken on the argument that they would improve the U.S. balance of payments.

The first thing that strikes one about these actions is the utter insignificance of the sums involved compared to the size of the problem. The deficit in the balance of payments has been running into billions a year. Our foreign aid, consisting mainly of gifts and soft loans, is more than $4 billion a year. The annual cost of the coal our forces use in West Germany is placed at $15 million. In the present fiscal year, 40 percent has already been contracted for in Europe, leaving about $9 million worth to be bought. So against the $4 billion we give away in foreign aid we “save” $9 million on coal, or roughly one-fourth of 1 percent. Put another way, we are to give in foreign aid 400 times as much as we “save” on the cost of coal. What we “save” in foreign exchange by cutting the duty-free allowance of American tourists is also insignificant.

BREEDING ILL WILL

Both actions are unwise from the standpoint of our foreign relations. The State Department is said to have opposed the decision to buy coal for our West German forces here because the German industry is also in economic difficulties. Our reduced tourist allowance will do great damage at special points—for example, at Curaçao, where Caribbean tourists stop largely for the “bargains.” We spend enormous sums to try to buy foreign friendship, and then offset them by petty “savings” that breed ill will.

These actions reveal above all a complete misunderstanding of the meaning and causes of a “deficit” in the balance of payments and the consequences of trying to cure it by reducing imports.

Let us consider first the differences between a real deficit in the balance of payments and a technical one. A real deficit is created by foreign aid—by goods (or dollars) that we give away for nothing tangible in return. A technical deficit in the balance of payments is the excess of gold and dollars that are transferred to foreigners on commercial account above those we get back. We may call this a technical deficit because the gold or money has not been lost; we have bought something in return for it.

IMPORTS AND EXPORTS

The point about a technical deficit is that, if a country avoids inflation or if it allows freedom of exchange rates, such a deficit will always tend to correct itself. The reason is simple. There is no advantage in foreigners’ holding on to that country’s currency forever. Eventually they must buy something with it—in that country. Given free prices and free currencies, changes in comparative prices or in exchange rates must in time correct payments deficits.

The present deficit in the American balance of payments has been brought about by unsound government policies over a long period. We have domestic inflation, reflected in costs, wages, and prices, making American goods high in price, and foreign goods comparatively attractive. We have a dollar overvalued in terms of gold, combined with arbitrary exchange rate fixity. Gold, which has not gone up in price in 25 years, is our biggest bargain for foreigners.

This situation cannot be corrected by discouraging imports. By the exact amount that we cut down our purchases from abroad, we ultimately cut down our sales abroad, by depriving foreigners of the dollar purchasing power to buy them. We compound our problem by paying up to 25 percent more for the coal we buy at home. Ironically, what we discourage is sales to us that enable foreigners to earn dollars to buy from us. We much prefer to give dollars away, while increasing the inflation that causes the payments deficit.