Thursday, September 4, 2008

Pay us like you owe us...

I have noticed that it has become very popular lately to refer to America’s purchase of oil from the Middle East as “the largest transfer of wealth in history”. This myth was made famous by T. Boone Pickens and has been echoed by many seemingly intelligent people, including Mitt Romney last night during the Republican National Convention. Considering that both of these gentlemen are extremely wealthy, I am surprised that they do not understand simple economics (or maybe they are just playing to the gullibility of the pubic).

A transfer of wealth makes one party better off and one party worse off. An example of a transfer of wealth would be redistributing money from Smith to Jones, such as what happens with many forms of taxation and corresponding government spending. In other words, one party gets something for nothing, and the other party gets nothing for something.

On the other hand, when Smith enters into a voluntary agreement with Jones to purchase corn in exchange for soybeans, for example, that is not a transfer of wealth; that is a trade. A trade makes both parties better off. One party sells excess corn for needed soybeans, the other party sells excess soybeans for needed corn.

When those “evil” Middle Easterners get our cash in exchange for the oil that we buy, what do they do with it? Do they spend it in their own country? No, because American dollars are not accepted by the hookers in Dubai. Do they use our dollars to wallpaper their palaces? No, but if they did we would be getting a whole bunch of fuel for the equivalent of a few hundred rolls of wallpaper.

Well then, what do the Middle Easterners do with the money? They send those dollars back to us in exchange for ipods, Dell computers, Microsoft software and all the other goods and services that we make here is the USA. Or maybe they give the American dollars to the Japanese in exchange for some Sony products, but the Japanese buy some cars from GM. Maybe the Middle Eastern folks invest the dollars that we sent them for oil in our capital markets. If so, those dollars are used to build new factories in America and create American jobs. When the Arabs pull their money out of our capital markets, they use the proceeds to buy our Sierra Nevada Pale Ale and our Fender guitars. In other words, when they invest in our capital markets or our real estate, they are choosing to consume our output tomorrow rather than today. However it may go down, those dollars get back to us, and American jobs are created in the process.

If T. Boone Pickens and Mitt Romney want to rail against transfers of wealth, they should take a look at government spending.

13 comments:

Anonymous said...

Where's China in your analysis?

When we were waiting for our "stimulus" checks, a friend commented that the Chinese were anticipating the income more so than US business.

Also, forget trading commodities - the analysis is not comparable to exchanging money for goods.

Do you genuinely believe that it makes no long term difference if we send money to other countries when we could be producing jobs and alternatives here now and into the future?

Freemarket said...

Where is China in my analysis? Replace any words that refer to Middle Easterners with "Chinese" and replace "oil" with "crap made in China". Oh, and replace "hookers in Dubai" with "hookers in China".

Explain this to me: what benefit is it to China if we send them our American dollars in exchange for goods made in China, but they never spend our money and get goods made in America? If they do that, we are essentially getting something for nothing. We may as well had sent them any empty box instead of money.

And trading commodities are the same as trading money. In fact there is a foreign exchange market for currency just like there is a market for corn and soybeans.

Oskar said...

Good point. It is trade, not wealth. This line made me chuckle though:
"but the Japanese buy some cars from GM"

Yeah, right. In 2006, the latest year I could find numbers for, GM sold just over 1000 cars per month in Japan. Another example would perhaps served your argument better...

Freemarket said...

Btw anon 6:28, we in Maryland could grow all our own oranges here rather than purchase them from Florida. It would be very expensive for us to do that, we have to build greenhouses or something to do it, and the land in MD that is now used for greenhouses and orange trees cannot be used for some other purpose.

But we would create Maryland jobs in the orange industry, right? And we wouldn't be transferring our wealth to Florida, right?

Anonymous said...

That's an extreme example. Your world must be so easy, black and white.

There is a bit of realistic and sensible gray area for most folks, though.

Freemarket said...

What kind of response is that? It sounds like you are just confused.

Oskar said...

For a good debate on the pros and cons of continued trade deficits, see http://en.wikipedia.org/wiki/Trade_deficit#Economic_impact

"The economist Paul Craig Roberts notes that the comparative advantage principles developed by David Ricardo do not hold where the factors of production are internationally mobile.[5] [6] Free trade concepts presume free floating currencies; however, in the real world, currencies such as China's are not free floating, while others may be manipulated by governments."

"Milton Friedman and Dewly Tiwana argued that trade deficits are not important as high exports raise the value of the currency, reducing aforementioned exports, and visa versa for imports, thus naturally removing trade deficits not due to investment."

It could definitely be argued that the continued US trade deficit (not "wealth transfer") has unduly lowered the value of the US dollar, thus causing much of the current inflation. Interestingly, some of the strongest public advocates of strengthening the dollar are the editors of Forbes, hardly a bastion of anti-trade...

FreeMarket said...

"The economist Paul Craig Roberts notes that the comparative advantage principles developed by David Ricardo do not hold where the factors of production are internationally mobile.[5] [6]"

I am not following that at all. To keep with the Orange analogy, Florida has a comparative advantage in growing oranges (probably an absolute advantage too, but nevermind that). If a new strain of orange trees were developed that could grow in cool climates (i.e. the factors of production became internationally mobile), China could now grow oranges. Florida can just do something else that they have a comparative advantage in, like grow potatoes, corn, or whatever. That is not necessarily good or bad, but it is more efficient. And comparative advantage still holds.

Oskar said...

Well, though I have an undergraduate degree in Economics I am not going to argue Pareto efficiency with a Cato and Hoovers fellow (and the "Father of Reaganomics")...

I'll leave that up to Friedman, et al.

Anonymous said...

Anon 6:33 a.m. - how is "gray" better than clear cut black or white? How chaotic your world must be!

Anonymous said...

Hmmm - let's see: "Clear cut black and white" gives us fundamentalism, the inquisition, Jihad, and Iraq. Gray gives us tolerance, secularism, respect for other's values, and scientific investigation. What's wrong with chaos?

Anonymous said...

Oh! another anon answered for me.

Thanks anon 8:32pm.

Actually, it was just an observation but I do agree with you.

Zinzindor said...

You know, FM, that somewhere in Shanghai there are posters to a blog (how do you say "anonymous" in Cantonese?), lamenting that their country is sending the US electronics and other consumer goods, and only getting weak paper dollars in return.