The Investment Scientist

Archive for July 2019

In macroeconomics, there is the balance of payments (BOP) identity …

Imports – Exports = Investments – Savings

This formula is called an identity, not a theory, because it is as true as 1+1=2. The identity basically says if a country imports more than it exports, that is, having a trade deficit, it is because the country does not have enough savings for its investments. (The chart below shows the saving rate of the US in the last few years.) The intuition is this. Foreign countries only have two ways to spend the money they earned from exporting to us, they can either buy our products, or they can lend the money to us. If we have a national saving shortage, we need them to lend us the money, not buy our products. This creates a trade deficit.

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On August 15th, 1971, President Nixon announced that the US would no longer redeem US dollars for gold, thus formally ending the gold standard. During the gold standard, the dollar bill was a certificate of deposit of gold which was redeemable to the bearer on demand. Post-gold standard, the dollar bill is pure paper money, what the academics call fiat money. Read my previous article The Gold Standard.

One immediate consequence was that the government could now issue money at will. And indeed, since 1975, the US has increased the money supply tenfold. As you can see from the chart below, the money printing accelerated in 2009, after the Great Recession. With this level of money printing, we actually need a lot of cheap imports to keep inflation at bay or else there would be too much money chasing too few goods.

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The Trade Deficit: Who Is The Winner?

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The June module at Oxford was all about macro-economics. The course was taught by a world-renowned economist, Professor Oren Sussman. There was so much I learned in the class that I can’t wait to share with my clients and readers.

The first topic I’d like to discuss is the Gold Standard. This will help us understand President Trump’s trade policy.

The gold-standard dollar
Below is a 100 dollar bill issued in 1888. Printed on the right side are the words “Gold Certificate.” From top to bottom, it reads “This certifies that there have been deposited in the Treasury of the United States One Hundred Dollars in Gold Coin.” Right below it is the italic “repayable to the bearer on demand.”

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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