How “Imbalanced Domestic Trade” disrupts a closed economy
Economists’ Trigger warning: — ding ding!
For Economics PhD’s: who have struggled mightily through five difficult years of indoctrination into present macroeconomics in graduate school, may be shocked into paralytic silence by being unable to figure out why the simple logic I will present is wrong, even with their hard won sophisticated mathematics.
The above is meant to be (mostly!) humorous–but ten percent serious–based on how some have seemed to react to this site content. I realize new ideas, even if old truths, are often challenging. I’m not trying to scare anybody–I’m hoping for honest comments–for which I will be very appreciative– at the end of the essay below. I did get a BS degree in math, not economics, so maybe someone can help me figure out what I may have done wrong. If so, I thank you!! — Ralph Hiesey
To skip this next (second!) introduction, click here to go straightaway to How “Imbalanced Domestic Trade” disrupts a closed economy” essay.
Present macroeconomics has successfully produced methods that can temporarily show how to fix recessions/depressions in an economy—yet will never be able to explain what is likely the most common cause of recessions/depressions. The reason it cannot is that assumptions from Paul Samuelson’s original economic macroeconomics, inspired by economist J.M. Keynes unfortunately do not acknowledge the “Fundamental Monetary Constraint” which will be explained on this web site, although I am highly respectful of what Samuelson and Keynes attempted to do. I will show that recessions or depressions periodically can easily occur in an economy caused by what I identify as imbalanced trade. This is much stronger logic than the present weaker claim that such recessions are caused by unexplained “low consumer confidence.” Instead of being caused by a vague psychological concept like “confidence,” I am identifying it with an economic monetary number: highly imbalanced trade, that I have defined, and can be quantitatively measured.
You might wonder: “Trade imbalance?? how can that happen in a closed economy? You can only have a trade imbalance when speaking of trading between at least two countries.” I will show why that is wrong—and how trade imbalance is just as possible, even likely, in a closed economy, meaning one with no international trade—and, when the imbalance is severe, just as destructive to a closed economy as has been recognized for well over one hundred years when international trade is badly balanced. Here’s what could likely cause this: in a very efficient modern economy with very productive robots, relatively few agents could be sufficient to supply enough goods/services for everyone’s needs–not requiring enough employment to provide income for needed adequate demand.
The roots of this web site reach back a long time ago to my senior year of high school, in 1959 when I wrote a paper for my senior American history class–trying understand why the booming economy of the 1920’s suffered a sudden and disastrous collapse. Suddenly twenty five percent of working people in the US were unable to find an income paying job. The GDP plummeted by 30% from 1929 to 1933. Ninety years later there has not been told a really satisfying story, to me at least, for why that happened. And that, despite development of the whole intellectual structure called “macroeconomics”— that was formulated after the 30’s depression with specific intention to unravel this mystery.
Just to be clear: I agree that standard macro does have methods that can correct the problem, even without knowing its cause: Keynes suggested that extra spending using fiscal and monetary policy could correct the problem. He explained that the problem was caused by lack of aggregate demand caused by “lack of consumer confidence.” But what caused that? That question supplied me enough curiosity energy to ponder for fifty years, and finally answer this question more satisfactorily—with exactly the same explanation that has been successful for over a century to explain the problem caused by international trade imbalance. This essay explains how trade imbalance can so easily happen even in a closed economy. The logic of the essay is based on almost exactly the same logic that has been used for a long time for international trade.
The closest explanation that seemed to satisfy many in the economics profession came from Milton Friedman, who purported to “explain” the 1930’s depression –NOT by explaining why it happened, but instead by blaming the FED for not fixing it. Unfortunately Fed Chairman Ben Bernanke swallowed that hook, line and sinker in 2000—leading to Bernanke’s unimaginably large increase in the US money supply in the decade after 2010, which money went to the top to make the rich much richer…. Well yes, maybe they should have “blamed” the FED, but that didn’t provide insight I was looking for to understand how the economy got so stubbornly weak in the first place for an entire decade. One bonus is that this analysis also strongly suggests how some economies can get stuck in a long term mediocre performance—called “secular stagnation,” which could have described the 1930’s economy. A second bonus is that it also explains the reason for easy development of high income and wealth inequality that is evident now. Policies to avoid this become more obvious from the analysis.
In the early 2000’s economists using their fancy macroeconomic mathematics—thought they had things explained pretty well—and under control; some thought it was completely solved and never would happen again Then another similar mysterious event surprised most conventional economists in 2008.
After fifty years I believe I’ve discovered the most likely common cause of recessions/depressions which are not explained by reduced ability to produce goods/services. But I am also eagerly looking for skeptics to challenge or improve my explanation! This web site will offer you the possibility to write and challenge the logic. I will publish all, what I judge to be serious, well crafted criticisms on this site . The purpose is not to “blame;” or even “argue.” What I’m looking for is further clarity for all of us to better understand how economies actually work.
This is described by the most important 14 page essay below: “How “Imbalanced Domestic Trade” disrupts a closed economy” which explains (1) exactly what causes trade imbalance and how it is measured (2) shows how that explains much current economic behavior not otherwise easily explained (3) Implies how tax policy and income transfers like Social Security can increase economic balance, and make the entire economy stronger, not weaker as some right wing economists seem to believe.
The whimsical “trigger warning” above is not completely a joke! I’ve begun to experience– that those who have been trained in conventional macro often don’t seem to have enough time to comment about the deeper, more important main hypothesis. I’m wondering: do they have a twinge of embarrassment that their model and fancy math confuses them (as it does me!)—which threatens some basic assumptions? Ok, maybe someone can write a brilliant response that refutes my possibly unfounded suspicion.
.Also on this site: “Monetary velocity—what determines it and what economic mischief can it provoke” which explains how, when different groups in an economy have great different monetary velocities, that can disrupt an economy. I’ve written what I believe to be a unique description for how the financial crash could have started the1930’s depression.
I’m also critical of the required crazy macroeconomic math ritual dance that seems intended to prove that macroeconomics is really serious and rigorous–just like physics! One example: some who claim they have “mathematically” proven an empirical fact, like “savings = investment,” not realizing that assumption was already resident in the premises.
Here is a link to two page short summary of the main difference between classical Samuelson macroeconomic description and the new explanation below:
Here follows the main essay, recently revised down to 14 pages. pdf file here for printing
At the end is an opportunity to express comments. .
How “Imbalanced Domestic Trade” disrupts a closed economy
Ralph Hiesey, November 8, 2024
Defines “balanced domestic trade” for a closed economy and why it is especially important for modern, highly productive economies. Uses logic well understood for international trade.
Section 0: For Keynesian macroeconomists: Description of the one assumption different from Keynes’ analysis
Section 1: “Trade imbalance” in a closed economy.
Section 2: International Trade Analysis: How Trade imbalance has long been known to negatively affect international trade. Later Section 3 will show how a closed economy can similarly be affected.
Section 3: How “trade imbalance” can happen in a closed economy.
Section 4: Some economic consequences explained by this analysis that present macroeconomics does not easily explain.
Section 5: Nine Additional Economic institutions which have historically evolved to help economies compensate for “imbalanced trade” even in a closed economy.
Section 6: Some Economic policy implications
Section 0: For Keynesian macroeconomists: Description of the one assumption different from Keynes’ analysis.
Paul Samuelson’s Economics is the name of the famous textbook published in 1948 which described economist J.M. Keynes’ macroeconomic analysis of what caused economic recessions/depressions. This new essay has economic assumptions almost identical to those used by Keynes, but adds one additional assumption that predicts additional important economic consequences. The purpose of my 14 page critical essay is to explain the additional economic assumption and to follow its important consequences, two of which are likely poor distribution of goods/services, and a related prediction of gradually increasing wealth inequality.
Keynes (almost tacitly) assumed that each of the “agents” in his economy were pretty much identical. In the math it was implicit that during each time period each agent produced (as income) about the same $ value amount of goods/services that the same agent purchased with that income (implied by the Keynesian Cross.) Different agents could have different incomes and value of expenditures, but for each individual agent the value of his income and his value purchased by that income was implicitly close to the same. Keynes in the math represented all agents into one big “single agent. The new analysis here differs because each agent’s income by selling goods/services over some period does not have to closely equal what that agent spends. This new analysis takes that into account which implies significantly different economic outcomes. This assumption is more realistic for any economy—but especially for recent more highly productive economies with some producers that earn much more than they consume.
Of course it must true in any closed economy that the total value produced and sold by everyone together in an economy must be equal to the value purchased in the same economy. That must always be true in a closed economy, and obviously was true for Keynes’ assumption—and for my assumption too.
Section 1: “Trade imbalance” in a closed economy.
If there are many in an economy that earn more than they spend, (during any period) that requires others that spend more than they earn. If these differences are large they can cause serious problems for an economy. This will be described in this essay as an economy in economic trade imbalance— meaning some have less than they need to spend, others have more than they need–which leaves some goods/services unsold. Keynes’ assumption guarantees that his economy would always be closely balanced. This essay defines, and studies consequences of the undesirable effect of trade imbalance, and how it is possible even in a closed economy with no international trade.
Difficulty of “imbalanced trade” has long been understood for international trade. What became obvious over time was that when countries traded with each other, net exporting countries would gradually accumulate more cash, gold or reserves which exact amount was transferred from the net importing countries. This practice was often even thought to be a good thing by mercantilists, who encouraged countries to export more goods than they imported to make their country richer—but which unfortunately made the importing countries poorer, and eventually even the exporting countries lost customers that imported their goods.
What is generally unrealized even now is that essentially the identical process, with similar bad result is even occurring now within single countries having no trade with other countries. You might ask how can trade imbalance possibly happen in a country that does not trade with another country? That’s what will be explained here.
Here’s an economic story to illustrate the problem: Imagine an economy with one giant mega supplier: the Mighty Amazoom Corporation with massive manufacturing and service locations throughout the country. They are so big that they can supply almost every possible product and service for everyone in the entire economy. They have incredible capital with super modern production robots that run 24 hours per day. They only require 20% of the population to produce all needed goods/services. Another 5% of citizens make a small amount of other services. No one else is needed to produce what is needed by everyone.
That sounds great. Economists should be delighted by such great economic efficiency. Only 25% of the population needs to work. So what’s the big problem? The problem is that seventy five percent of the population has no job and no income! The British call these people redundant. But how can those plentiful goods/services get purchased? Only 25% of people have jobs and income. How could Mighty Amazoom possibly sell more than 25% of its potential output when so many are without jobs? Such an economy would have under performing GDP, with many citizens unsuccessfully seeking jobs to pay for stuff. It is even difficult to see how such an economy could possibly function. Section 5 of this essay will show that other helpful economic institutions have spontaneously developed to partially compensate for this kind of problem. One purpose of this essay is to explain why these institutions needed to be brought into existence to make an economy work better.
An equivalent way to describe the same problem is to understand that there are two separate reasons jobs are needed in an economy:
- Jobs are needed to produce products and services that everyone needs.
- Jobs are needed for people to get income to buy products and services that they need.
The economic problem that makes distribution difficult: There is nothing that guarantees that #1 is equal to #2.
This is no fantasy for contemporary economies. We already have some creeping contemporary examples such as Amazon and Walmart who have driven many out of small businesses, although under capitalism they are doing just they are supposed to do. Automobile and electronic production employ many fewer workers to produce much more value in goods/services than 50 years ago. In the US some manufacturing has been moved to China and Mexico. As the number of needed workers becomes smaller, wage competition for fewer jobs drives wages lower, which has been even more obvious since the 1980’s. Low wages then reduce aggregate demand even more for an economy as customers have less money.
This wasn’t a problem in the US in 1790 when 90% of the population of the US was employed only in agriculture. There was a heck of a lot of work to do! Now only 1% live on farms, but 100% of people need to eat, which is one reason why this problem is much more evident now.
Some economists claim that economics is about how people make choices under conditions of scarcity. Perhaps that was true in 1790, but today, a visit to any US shopping center, if you peek inside a Walmart or Costco with goods packed from floor to ceiling it is hard to believe the scarcity story. Now, for at least 50% of the population, the real problem for them is to have enough money to buy it, or enough credit, or jobs that pay enough to pay for it. This essay is more focused on that contemporary reality. For many the problem now is scarcity of money.
This creates great differences in income and ability to save money. It gives some hint for why today 50% of the US population owns a tiny 2% of the total wealth. And how a tiny 2% of the population owns 50% of the wealth.
One reason I am critical of contemporary macroeconomics is that productivity has moved to a point where much cheaper production of goods/services and less production labor is possible. Macroeconomics in advanced economies now needs to focus more on goods and income distribution rather than maximizing GDP. Nothing even close to wealth equality is necessary for significant economic improvement. If income could shift just enough to move these percentages so the bottom 50% wealth cohort possessed 4% instead of 2% of total wealth, that would mean a doubling of wealth for the bottom half the population, with very little decrease from 50% to 48% for the top 2%.
I will analyze a closed economy the same way international trade has for hundreds of years been analyzed. There is a surprisingly close comparison to a closed economy. I have taken from international trade economics three economic measures that are quite useful: trade balance, current account and capital account.
Section 2: International Trade Analysis: Trade imbalance has often long been known to negatively affect international trade. Later Section 3 will show how a closed economy can similarly be affected.
Mercantilism: In the sixteenth to eighteenth centuries some countries had a policy of deliberately exporting more products/services than they imported, with the purpose of building up higher reserves or money from the importing countries, which would make it easier to enable them to import goods. This was called mercantilism, which especially in the seventeenth century was considered by many economists to be the best way to build wealth for a country. That is usually hardest on the importing country, but the exporting country also could experience a lack of demand for their exports which could also reduce their GDP. So both countries lose when this continues. As this problem was better understood, mercantilism went out of fashion, and considered unworkable international trading policy because it often eventually discouraged international trade for both exporting and importing countries, and in some cases increased conflict among nations.
With international trading countries there are three important commonly used economic terms: trade balance, current account and capital account. Current account quantifies the amount of trade balance of a country: It is the total value of goods/services a country exports minus the value of total imports of goods/services within some period of time. So for a net exporting country trade balance is positive, and for net importing country it is negative. Mercantilists advocated positive current account balances in order to accumulate money—which with just two countries trading gradually transferred money from net importers to net exporters. Each country has a matching capital account which measures the cash reserves that flowed the other way, from net importers to net exporters to pay for those goods/services. As mercantilism faded, more attention was given to capital account, to see what a country was losing in capital—especially when it imported more than it exported.
One remedy to shift better trade balance with international trade is possible if the currency exchange value between two types of money is allowed to adjust between the two countries. Users of money of the net importing country can reduce the value of their money when they exchange it with money of the net exporting country, which will tend to equalize the value of trade between them. It is well worth noting that this advantage was eliminated when the Euro was adopted as the common currency for European nations. This has been regarded by many economists as being a weakness, or mistake that has caused difficulties making the Euro work as common currency to balance trade among many European countries. This puts different countries into one monetary straitjacket that disallows them from adjusting currency exchange rate to balance trade among countries.
And of course this is not a method that could ever be used among citizens within one economy to resolve imbalances within that country, since everyone uses the same money.
Section 3: How “Trade imbalance” can happen in a closed economy.
Like countries with unbalanced international trade, a closed economy can have a similar trade imbalance. Some agents in an imbalanced closed economy can be described as “domestic exporters” and others in the same country as “domestic importers”. Imbalance increases wealth for exporters and reduces wealth for “importers” similarly as can happen in imbalanced international trade.
To me, it is remarkable that for over 100 years this possibility has been so well recognized with respect to international trade, but still not recognized as possible within just one economy.
A light mathematical discussion will describe how trade imbalance can occur in a closed economy with imbalanced internal trade. Distribution of goods/services becomes difficult. Wealth inequality can easily develop. In section 5 there are additional economic institutions described that have historically developed to reduce the problems caused by domestic trade imbalance. They have a function similar to what capital account is intended to illuminate in international trade.
In international trade, trade imbalance happens when one country is a net importer and the trading partner country is a net exporter. Of course in that case all the net importers live in one country, and all the exporters in the other. In a closed country all the importers and exporters are mixed together in the same country. Each person (agent) must fall into one of two categories: (1) a net domestic exporter who produces more income value of goods/services than he/she spends for such goods/services (savers); (2) a net domestic importer who spends more value in goods/services than his/her income value has produced (dissavers).
Similar to international trade, for each such agent we can measure the imbalance by their domestic current account which is the total money value goods/services that agent has produced (income), minus the total money he/she spent for goods/services (expenditures) in the same period. Therefore domestic current account is positive for domestic exporters and negative for domestic importers.
Another important number $C in a closed economy can be defined by combining all net exporters’ domestic current accounts together during one period, (=$C). I define this important number as the “total domestic current account” which is the total internal trade imbalance positive number for all the exporters lumped together in the closed economy.
If $C is zero during the period, that would be the simplest to visualize—meaning that every single person purchased in value exactly what he/she earned, with no one having either saved or dissaved. I define this as trade that is equally balanced. Of course this doesn’t mean everyone’s income was the same. But if ($C) is positive during some period, then all the exporters (savers) would have produced a total of ($C) more in value of goods/services than they consumed. Where did those extra ($C) goods/services go? They went to the importers (dissavers) who would have spent a value exactly ($C) more, which must have come from money the importers (dissavers) had saved previous to that period. So the importers have a current account number that is same magnitude, but with opposite sign of exporters.
This would be no problem for the net positive exporters (savers), but there is the possibility that some of the importers (dissavers) could run out of savings–and therefore would not be able to purchase some of the excess product/services that the exporters had to sell. If that happened it could be bad not only for the importers, but also for some of the net producers who would have been left with extra inventory they didn’t sell which would mean reduced GDP in the economy; the greater the trade imbalance, the more that GDP could be reduced. This is exactly the same bad consequence of trade imbalance as has long been recognized in the international trade case.
A way of evaluating the severity of the imbalance could be measured by dividing $C by the GDP: $C/GDP.
“Capital account” in a closed economy? Under international trade it was explained that the capital account measures the money or gold or capital flow that importers paid for traded products they received from exporters. A similar mechanism needs to somehow happen in a closed economy—to explain how people that save would recycle their money back to importers from which they received it, otherwise an economy could eventually grind to a halt. Economist Keynes identified a liquidity trap which he believed could slow an economy. I now realize there are many examples of economic institutions that evolved that moved money similarly as “capital account” required, or transferred goods/services without money transfer, which will be listed in Section 5 of this essay. Government taxation to purchase public goods for citizens is just one common example. Another are banks that borrow money from exporters and loan to importers so they can continue to consume, but unfortunately that gradually transfers some interest back to exporters.
The surprising result of the above analysis is that if goods/services are all exchanged by money—in a100% capitalism economy, saving is just a transfer of money from importers to exporters which means it is a zero sum game! –exactly as is true with imbalanced international trade between two countries. One macroeconomic fact this explains is the high wealth inequality we observe today.
How do we resolve that logical conclusion with FRED data that shows that total saving is not always zero? https://fred.stlouisfed.org/series/PSAVERT
That is resolved in Section 5 —where “Capital account” compensation comes in to play. One example: Federal Government that virtually always goes into further public debt—which is one important method that allows private saving to be possible. Public debt is not just a terrible vice for which many believe governments are guilty—public debt is one way that makes it possible for private citizens to save. Secondly, non financial business also goes into debt by selling corporate bonds which also allows households to save. Thirdly, exporters have extra cash savings that they can loan to importers, although that puts dissavers in even greater debt with interest they need to pay. All these and others will be described in more detail in section 5 and 6—which shows how equal debt is created when savings of money are made.
Section 4: Some economic consequences that present macroeconomics does not easily explain.
The previous three sections have described a new way that a closed economy ca be driven to a recession or depression. Using a new definition of trade imbalance for a closed economy, if such imbalance is present, money is gradually transferred from domestic importers to domestic exporters that eventually reduces aggregate demand by domestic importers, which reduces GDP. Instead of citing what Keynes called “lack of consumer confidence” as a cause of recessions, it shows how recessions can be caused by a measurable economic variable called trade imbalance that is the cause of reduced aggregate consumer demand. The argument follows the same logic used for over 100 years that shows how trade imbalance in international trade causes money to flow from net importing to net exporting countries. Reaching this conclusion only required modifying Keynes’ simple single agent assumption to allow agents to be both importers and exporters. Section 5 shows how debt can accelerate wealth difference between domestic importers and exporters..
Wealth disparity between the bottom 50% and top 2% is one of the most obvious distortions to the US economy—but similar slightly less severe distortion has characterized other advanced economies—which could be an important cause of widespread political/economic dissatisfaction in otherwise high performing economies.
The next two sections examine some economic consequences—with section 5 showing development of economic institutions that have historically developed in part to correct the most egregious forms of distortion caused by imbalanced trade.
1. Improving Keynes’ macroeconomic theory that explains and corrects recessions/depressions: Before the 1930’s economists were frequently puzzled by economic events marked by slowdowns in GDP, and accompanied by increase of unemployment that would happen seemingly for no obvious reason. What was particularly puzzling was that they occurred not with shortages of goods for sale because they were often accompanied by what were called “general gluts” of a wide variety of goods. These were mysterious events for economists because it was generally believed that economies could fail only if there were insufficient production of goods/services, not an excess. Often these events were described as an economy that would unexpectedly develop a lack of aggregate demand. Or such events were sometimes even described as caused by “overproduction.” During such recessions there was desire for such goods from part of the population—particularly those with high unemployment who had insufficient money to purchase goods/services.
Despite the frequent recurrence of such actual economic events some economists said such events couldn’t possibly happen; because they didn’t fit their theory about how a capitalistic economy was supposed to work. People called supply siders would mistakenly insist that what is needed is more supply, or even tax cuts for the rich.
In 1948 economist Paul Samuelson published the first edition of his famous textbook Economics that described what was called Keynesian macroeconomics. He presented Keynes’ important insight about why recessions happen and how to fix them. Keynes observed that such recessions/depressions appeared to be caused by reduced aggregate demand in an economy–an explanation perfectly good for predicting the existence of general gluts often observed in sluggish economies. However he didn’t attempt to explain what caused this reduced demand except to suppose that for some reason it was caused by a reduction in “consumer confidence.” Even now that same description is often still used. He therefore recommended that government deficit spending should be implemented to increase aggregate demand. This essay is suggesting that lack of consumer confidence could be better explained by an economy that became trade imbalanced, shifting wealth from net importers to net exporters. That would explain low confidence not for all consumers, but mainly with the subset who were the importers (dissavers) in the economy –some of whom may have been unemployed for a while because of the imbalance of trade.
The best way to prove or disprove this hypothesis would be if we had real time information about trade imbalance ($C) within a country. So far as I know the Fed does not collect any such data on domestic trade imbalance that would be able to test to see if that imbalance is associated with such economic downturns. Another reason that might be evidence for this view is that consumer confidence, according to the Investopedia website, has been more commonly observed as a lagging indicator of unemployment, suggesting that it is likely to have been caused by some earlier event– which could be an ongoing increase of trade imbalance.
Why did Keynes did not come up with this explanation? Possibly because he visualized the set of agents as being all equal—not imagining an economy in which the group of agents could divide between domestic importers and domestic exporters. Samuelson’s classic text assumed a single agent model that is only capable of describing a perfectly balanced economy. This assumption was also implicit by the 45 degree angle Keynesian cross that implies that the money obtained by producing goods/services would be closely equal to what it cost to purchase them. But there is a hint that Keynes might have considered the imbalance view because he also considered the possibility of a liquidity trap—meaning some fraction of wealthy agents in the 1930’s were not spending, but holding excess cash liquidity as wealth. My hypothesis assumes that imbalance of trade could have caused eventual high savings by exporters to increase over time, which would imply that they trapped more liquidity—though the way Samuelson formulated the consumption function in the model he described in his textbook didn’t allow this possibility to be visible.
2. Why economic growth is often considered to be so important. Zero percent growth is usually considered a sign of a faltering economy. Why? Economic expansion is NOT needed because we need more stuff! Higher productivity can have an economic negative. As productivity increases within an economy, by definition fewer hours per worker are required for the same GDP output. Therefore some workers become, as the British say, redundant. To maintain aggregate demand the economy must find new jobs to provide income that will enable laid off workers to consume what they formerly did, plus value of the new goods/services provided from the new jobs that needed to be created. When productivity becomes more efficient, growth in GDP must occur not because more goods/services are needed, but rather to maintain the income for redundant workers that allows all goods/services to be distributed and consumed. I would suggest that this would be an excellent topic for economists to analyze and try to find solutions to allow greater productivity without needing to produce more stuff. Some institutions that have already evolved historically are listed in Section 5.
3. Does mercantilism exist within a closed economy? Although mercantilism has been for two centuries understood as bad policy for international trade, the corresponding attitude in a closed domestic economy is usually exactly the opposite: the belief is expressed by economists and moralists that saving, by producing more than consuming, is highly praised, which leads only to virtuous outcomes, without understanding the negative consequence of imbalanced trade as we have defined it for a closed economy, that has been well recognized as a problem caused by imbalanced international trade. For some, belief in the undeniable virtue of saving as a spur to investment will likely be enough reason to completely reject the logic being expressed in this essay. An example: British economist John Hobson, who expressed in the early twentieth century a view similar to what is expressed in this essay, found strong opposition from economists to his thesis that excessive saving could result in reduced economic performance. Near the end of his life in 1938 he wrote his final book with the wry title Confessions of an Economic Heretic. My personal confession is that knowing his fate I have avoided saying there is a problem with “too much saving”–but it is true that another way to describe those who consume much less than they produce is to use the “s” word: savers.
4. Lazy bums? The methods to be listed in Section 5 will be some that have been used to compensate for internal trade imbalance. If the economy does not provide sufficient compensation for an imbalance of $C, that requires some in the economy to dissave. Some in the economy who have wealth may think that those who don’t save must be lazy bums. Maybe that’s also true, but if there is insufficient compensation for a high $C imbalance, it will be impossible for everyone to save. Perhaps blame the savers for saving too much. However bad macroeconomic policy, by not using more effectively some of the methods to compensate described in Section 5 , would likely be a more useful target for their criticism.
5. Problem for our economy: Robots: Production equipment such as robots have taken the place of workers for much production work. Fewer people run the robots, reducing worker employment. Some people mistakenly believe that more college education is needed for redundant workers so a similar number of workers will be able to run the robots and will thus increase their income. But the whole point of using the robots is to produce the same output with fewer people, tending to increase profit per worker, which tends to increase the value of imbalance +$C. Production engineers help to produce goods more efficiently, often meaning using fewer people to produce the same output, increasing internal economic trade imbalance. Macroeconomists frequently tout higher productivity without understanding its possible negative effect on income distribution. Walmart and Amazon are recent real life contemporary examples.
6. Problem for our economy: Shifting to cheaper production labor in China and Mexico. Another possible recent cause is that much high labor intensive production has been moved out of the US to reduce labor cost, which further decreases the number of domestic workers having well paid jobs. So with lower labor cost, pay for management increases—while redundant and unemployed workers become in higher supply increasing the economic imbalance +$C within the US economy.
Section 5: Nine Additional Economic institutions which have historically evolved to help economies compensate for “imbalanced trade” even in a closed economy.
In this section 5 we relax the condition that all money exchanges between agents happen only by exchanging goods/services. Each example here shows a method of transferring goods/services without requiring an equal transfer of money value between agents. I know!! some of these may sound suspiciously like (eeeeeek!) socialism!! But they are necessary for successful transfer of goods/services when some agents produce much more than they consume. Ideally to effectively transfer and consume goods/services, all methods in total would compensate the value +$C of imbalance. These describe institutions that in international trade are how Capital Account balances Current account. If the compensating amount is less than that amount, aggregate demand could be weak. If there were overcompensation, possibly pushing $C to a negative number, that would increase aggregate demand beyond supply and risk over demand with possible inflation.
Method 1: Government taxes and spending for public services: An important purpose of taxes is to pay for needed public services that are more efficiently provided by a government single payer than would be practical to be provided by individual private funds. For accomplishing only this purpose it does not matter from which group: exporters or importers that such taxes are collected—or to whom they are distributed; at best, political decisions about who to tax are made with some consideration of fairness. Or at worst, by considerations based on how much particular citizens promise to contribute to political campaigns.
However, for balancing trade emphasized in this essay, government taxes can usefully also provide rebalance of trade in an economy to maximize distribution of goods/services. To serve this purpose taxes must come from exporters or savers that when spent on public products/services will be able to rebalance an accumulated total internal trade imbalance that will allow flow of goods/services to importers. A problem for using only this method to completely rebalance an imbalance of $C, is that taxes must be collected from exporters in the same total amount $C. To accomplish this task using no other method would be extremely unlikely because that would require a tax equal to the total of savings accumulated by all exporters which would then leave no money left for the exporters to keep as savings. Fortunately other methods exist that will be described, using the loanable funds market that enables exporters to add to their savings that earn interest. Taxing importers will usefully supply money to purchase public goods, but be of negative benefit to achieving trade balance since such tax will decrease importers’ ability to purchase goods needed to help achieve the objective of balancing trade. One of the very worst tax policies possible worsening trade balance is to reduce taxes on the wealthy, which would likely increase savings made by the exporters who even before they are taxed do not even purchase enough goods to make up for the excess they produce.
Method 2: Increase pay of importers An example could be laws that establish higher minimum rates of pay, which would benefit almost always non savers. The total amount of additional pay in the economy gained by importers would reduce $C by that amount of additional pay, assuming the money was subtracted from highly paid exporters that were paid more than they consumed..
Method 3: Government transfer payments: Transfer payments that take tax money and transfer it directly to citizens is another effective means to accomplish rebalance. Three important methods in the US are Social Security, Medicare and Medicaid. The US payroll tax is unfortunately a regressive flat tax that is quite high at 15.3% on income that is taken from people with incomes from as low as $400/year to those with income less than $140,000/year, therefore a lot comes from importers, not exporters. That tax is immediately distributed to one of two places. (1)Most of the tax goes to Social Security and Medicare recipients—which likely gets transferred to recipients who spend it rather than save it, which would have a positive balancing effect. (2)The rest of the tax (if any is left) goes to purchase Treasury Bonds (via the S.S. Trust fund) that always immediately pay for government expenses. Therefore this sources money from many importers and some exporters and then is spent for government expenses which compensate for some trade imbalance. The amount that this method can compensate for $C of imbalance is the total amount that is collected from exporters minus importers. As said before, any tax collected from importers reduces their ability to even compensate for what the importers have produced, so will negatively count as compensating for the trade imbalance. If the 15% tax were to be extended to all income above $140,000, including investment income, that would surely be more beneficial for reducing the $C number by placing this high (15%) tax on mostly exporters with high incomes, which could benefit the entire economy—both exporters and importers.
Method 4: Earned Income Tax Credit: The earned income tax credit shifts US income taxes in the US from 31 million importers/dissavers to many other exporters/savers by reducing taxes on those with low income who are very likely to spend all of their income. The total value of such credit for 2022 was $64B. So that the corrective value $C resulting from that is likely $65B minus the marginal part of that additional tax that had to be collected from importers. Many may view this as a burden produced by those who are under producing workers. However this essay show why it increases GDP since likely most of the $65B of money credit will be spent by importers rather than saved.
Method 5: Government spending by increasing public debt. Fiscal policy: Government can obtain revenue by selling Treasury bonds mostly to exporters in the economy. The money is spent on government operations which creates economic demand nearly dollar for dollar that will compensate for total internal trade imbalance. This is a beneficial method because the revenue comes mostly from exporters looking to save their cash money as Treasury bonds. Unlike the government tax described in Method 1 above, this is a way of obtaining funds from exporters that allows them to feel like they are simultaneously keeping possession of their wealth as their savings but saving in form of a Treasury Bond earning interest instead of holding cash.
But doesn’t this backfire later? It might seem that such bonds, when paid back at the end of the term would reverse the benefit just cited—which if that ever happened would be a serious defect with this method. That seeming drawback has been mostly successfully avoided by making (nominal) Treasury debt always increase—so in effect the debt amount never goes down, because there are always new purchasers of such debt seeking for a place for their savings that is more than sufficient to roll over Treasury debt which reaches the end of its term. This is aided if inflation happens—which reduces the real value of already borrowed debt, and also increases the nominal value of new debt—making it easier to roll over previous debt. The nominal total value of US debt has never gone down since at least 1955, except for an extremely small amount in year 2000, so that using this beneficial Ponzi scheme in practice permanently transforms cash savings from exporters back as spendable public cash money. But the present total of debt being over 100% of today’s GDP means it cannot ever realistically be paid back which makes it close to a Ponzi scheme. Past debt stored as treasury bonds gradually gets its real value crushed down by inflation, often more rapidly than it increases in nominal terms, although as said it virtually always goes up in nominal terms. However this Ponzi procedure is completely for public benefit, and where no one is ever likely to complain about not getting their money back–because the Fed can print redemption money–although there is no guarantee that those dollars will be worth as much as they were originally. Inflation is usually thought as a unequivocally bad economic event, but this shows one positive public benefit that it can provide to taxpayers.
But what about interest on public debt? It is true that interest paid tends to go back to the savers, which would make this Method 5 less effective. But inflation also reduced the effective interest paid, so it is borrowed at virtually zero real interest rate. This has been described by some as financial repression.
Is financial repression a good thing? Financial repression been the denigrating label that has been used to describe government policy to keep government bond real interest rates low. According to the website Investopedia:
“The [financial repression] concept was first introduced in 1973 by Stanford economists Edward S. Shaw and Ronald I. McKinnon to disparage government policies that suppressed economic growth in emerging markets……..A government steals growth from the economy with subtle tools like zero interest rates and inflationary policies to knock down its own debts.”
However the analysis in this essay shows how this so called “repression” benefits an economy by reducing interest rates on government debt. It takes no difficult economic analysis to see that such policy reduces the flow of money from Treasury bond interest paid by less wealthy taxpayers to the more wealthy individuals who can afford to buy Treasury bonds. Contrary to claims that it “steals growth,” if such interest savings are used to reduce taxes mainly to importers it allows them to increase their after tax income, without reducing government expenditures, resulting in increased GDP. Here is a graph showing nominal public debt in the US since 1965. It shows that this method has soaked up over $25T of past cash savings since 1965 that has been converted by savers to non transactional Treasury debt, never to be paid back partly by help of beneficial inflation. Method 6 is an identical process for which private debt has the same ability to reduce internal imbalance https://fred.stlouisfed.org/series/GFDEBTN
Why perpetual bonds are useful: An historical example from the UK that avoided the backfire of having to pay debt back were perpetual bonds, called Consols that never needed to be paid back. In some instances, after issue the interest was reduced.
Method 6: Private Financial markets historically developed that allowed domestic exporters to lend money to domestic importers through credit, such as loanable funds market. This would move the economy to better trade balance. Exporters likely have extra saved money. Importers lack it. So it is useful, and not surprising to see how a market for credit naturally gets created by a domestic trade imbalance—with exporters having money they want to loan to importers for interest. This is very similar to Method 5 that described how public debt is a means of converting cash to a form of credit, called a Treasury bond. Similarly, financial markets, such as banks and bonds, including credit cards, are private debt versions that developed so that exporters can save their cash money with a bank savings account, or purchasing a corporate bond which will then be loaned to others becoming a saved asset to the exporter. The logic is the same as for public Treasury bonds, except the money is used for private instead of the public spending.
The general term loanable funds is a way to save money in a bank or bond by loaning it. One way to describe this is to describe it as increasing the velocity of money—since the same money can be lent repeatedly almost simultaneously going round and round to purchase different goods/services . As money is successively used, instead of using up cash, debt is piled higher and higher—in 2024 having reached an amazing $100 trillion dollars since 1955. If such public or private lending were not possible, and all saved cash were literally saved in a lock box, exporters would eventually rather quickly scoop all cash into boxes, thus shutting down an economy with little cash left for spending.
This makes it possible to make far more spendable money available, and also to simultaneously save far more massive amounts of money than would be possible if holding cash money were the only method of what is called “saving cash.”
Traditionally, before the 1930’s, saved money from exporters was assumed to be all, or almost all, used only for investment purchase—meaning for something that would enhance productivity of goods/services. However a recent article by Amir Sufi, Atif Mian and Ludwig Straub has shown that very much of recent such loans have been to households to purchase needed consumption goods. They have called that spending “Indebted demand.” The Saving Glut of the Rich” (working paper), and “Indebted demand” published in Quarterly Journal of Economics, November 2021 are referenced by these links. They show that such loans cause a short term boost in economic demand, but eventually reduced demand and GDP as the debt load gets higher on those who don’t have enough credit to continue to borrow. They also believe that interest rates have decreased as wealth of the rich gained ever greater loanable supply money available, and debt interest burden has gotten higher for borrowers, thus lowering money loan demand.
This graph shows total residual public and private debt that has not yet been paid back in the US from the 1950’s to the present: In 1950 it had nominal value of $389B but now is equal to $99Trillion dollars, virtually for all recent time an always rising number “All sectors; Debt securities and loans” . https://fred.stlouisfed.org/series/TCMDO . It burdens taxpayers with interest expense which represents an income stream from those of low wealth to others of high wealth, however this interest burden has been beaten down by inflation. This immense total can be seen as a record of accumulated past savings that have been converted over seventy years’ saving of cash into debt, never having been reduced, now fossilized unto to a huge pile of bonds and other means of paper debt that represents in value nothing more tangible than a “promise” to pay money eventually. It represents over $300,000 borrowed for payment of products/services delivered (on average) to every man, women and child since 1955– that is way too huge to actually ever be paid back.
One recent book about the problem caused by such immense debt has been written by economists Amir Sufi and Atif Mian in 2014 entitled House of Debt.
Though there are a few people that believe that such disastrous debt must eventually be paid back—as long as enough inflation is built in to the economy, it will not ever need to be paid back. And it has had tremendous benefit to the economy—$100 Trillion worth of goods/services additional GDP going back to 1955 have somehow been consumed by citizens that they did not have to pay anyone—except for the money that was needed to pay for interest on Treasury and private debt. The $100 Trillion was likely paid for almost all by wealthy exporters who purchased Treasury bonds to save their money.
The flip side of the act of loaning is described by economist Richard Koo—When events of economic austerity have been declared necessary by economic “experts,” high amounts of loanable funds have been paid back to the original bond purchasers. This reverses the loan process, resulting in what economist Richard Koo describes as a “balance sheet recession” which causes an economy to go into a downturn—having the opposite effect they had when they were generated.
If interest rates are too high, loanable funds are likely to be in low demand, slowing an economy. On the other side, if interest rates are too low and credit risk to lenders is high, money supply may be low being held in a “liquidity trap” of saved money. This can cause wealthy people to hold their savings without loaning them, having the same effect as the Fed when it withdraws money to slow an economy. I suspect his quite likely was an important cause of lengthening the 1930’s depression.
Method 7: Increase GDP by increasing production of new goods/services targeted to exporters. Create new jobs to produce new products/services to sell to exporters that can maintain GDP by moving money from exporters to importers. This is why an economy must grow. It is not because the economy has need for more stuff. Production of more stuff is necessary to provide jobs, and thus generate spending money for the redundant workers so they can continue to purchase what they were spending before, plus the new output they are producing with their new jobs.
Method 8: Persons default on credit debt: Default on debt amount of $D will decrease imbalance by the amount $D. However, if the creditor is judged “too big to fail,” the Fed may decide to print money for the default amount for the creditor. This will improve the monetary wealth of the creditor by $D. The amount of “credit” will be converted to “cash” which will increase the money supply by the amount of the default.
Method 9: Agents can give gifts of products/services to others: For example several agents can combine into one family to act as one agent. One family member earning sufficient money can distribute goods/services to support others in the family. Of course for this to happen individuals need to have incomes adequate to support more than just themselves. Charities funded by people who earn enough income can provide necessary products/services to others who can not afford to pay.
Section 6: Some Economic policy implications:
- High “Domestic trade imbalance” has been defined, which forces poorer income distribution and lower GDP. Rather than increasing GDP being the main objective, now with highly productive economies a more important economic objective is good distribution of goods/services, which can increase GDP to a more broadly diverse group of income recipients.
- This essay does not claim incomes should be more equal. It does claim that the $ difference between agents’ incomes and their spending should be reduced.
- Taxes should be placed most heavily on those agents classed as “Exporters” to improve domestic trade balance.
- Minimum wages should be established in an economy to reduce income imbalance to obtain better domestic trade balance and distribution of all produced goods/services.
- Incomes very high compared with the median will usually increase economic trade imbalance, and should be discouraged by high progressive income taxes. The US economic history in the 1950’s strongly suggests that this does not weakens an economy.
- Tax on wealth is said to be difficult to enforce. A difficult to evade method can be constructed by building deliberate inflation into an economy. Reduce impact to those with low wealth/income by a fixed, constant guaranteed annual income for everyone. Pay with progressive tax on “exporters” who are wealthy.
****************
.. My objective is to improve understanding of economics. I am eager to receive serious comments or criticism from readers on the above content to correct or improve it. To prevent spam, these comments are moderated, so they will not immediately be displayed.
Name and email are required. Your email address will never be sold, or leave here. A website is optional if you wish to display it.