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Money Leaving the Country

April 11, 2012

When an American buys foreign goods using U.S. dollars, the foreigners cannot use the dollars for domestic consumption; they must use their own native currency. They must turn around and either store the currency, buy investments in U.S. companies, buy U.S. exports, or buy U.S. government bonds. Blaming the out-group for our problems feels good, but isn’t supported by economic theory.

Storing the Currency
About $200-$250 billion dollars were stored abroad in the form of currency, as of 1995. As the total amount of currency circulating has approximately doubled since then too, I would guess that the amount of currency held by foreigners is around $500 billion. At first glance, it may seem as if more money for foreigners means less for the U.S., but this is not the case under a fiat money system. What matters for stabilizing U.S. inflation/GDP is not the total amount of dollars existing in the world, but the amount (and speed) of dollars circulating in the U.S. Thus, if dollars are taken out of circulation and horded by foreigners, the U.S. Federal Reserve can simply print up more to make up the difference. Foreigners holding U.S. currency has basically no impact on U.S. aggregate demand, investment, or any other macroeconomic variable, so long as the rate of hording is anticipated or relatively stable.

Buying U.S. Exports
If foreigners use their money to buy American exports, they are contributing to the economy just like any other actor in an economy. They produce, and trade what they produce for other goods for which they do not have a comparative advantage. Such trade has long been known to be welfare improving for both traders/countries/whatever. The money goes, the money comes back, and everyone gets what they want for a lower price than what they could have gotten otherwise.

Investing in America
If foreigners use the money from exports to buy stocks and bonds in American firms, the money still winds up being spent in the U.S., just on capital goods rather than consumption goods. American firms increase the capital they have, become more productive, increase wages, and pay profits back to the foreigners in exchange. The dividends/bond payments can be spent however the holders of the stocks/bonds see fit, and we are back to square one. Once again, this option benefits both parties.

Government Debt
When a foreigner buys debt, they are paying for government spending that otherwise would have been paid for by an American, either through taxation, domestic borrowing, or inflation. By driving down the interest rate faced by the government, they make government spending cheaper than it would have been otherwise. However, when the bond is due, the government must increase taxes to pay back the foreigners. However, assuming the government spending would have occurred anyway, taxes would still have been increased had the bonds been sold domestically. The only difference in this scenario is that instead of domestic investors lending the government the money (and being paid back), now foreign investors lend the money and are later paid back.

Now, some people have told stories about how a foreign government holding a ton of bonds might adversely influence government policy, but I don’t find them credible at this level of borrowing. Perhaps if borrowing were drastically increased, but then it’s better simply to reduce government spending rather than worrying about how it’s being funded.

Further Reading
Chinese goods and services only accounted for 2.7% of U.S. personal consumption expenditures in 2010.
Spending, Money and Time
Government bonds are strange

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