As noted in my previous column, foreign holdings of US dollars are classified as foreign holdings of US assets and, thus, contribute to US trade deficits. But as I argued, it would be perfectly reasonable to classify foreign holdings of US dollars, not as holdings of US assets, but instead as foreign purchases of a US export — purchases, specifically, of the services of an especially useful currency to hold or for conducting global commerce.
Because the global demand to hold US dollars or to use them to conduct international commerce is high, this alternative classification would dramatically diminish the size of reported US trade deficits. These ‘deficits’ being the excess of US imports over US exports, this alternative classification would reduce US trade deficits by increasing the reported amount of US exports relative to US imports. (Because trade – or “current-account” – deficits are exactly offset by capital-account surpluses, another consequence of such a reclassification would be to decrease the reported size of US capital-account surpluses.)
Measured trade balances would change significantly with absolutely no change in the underlying economic forces and facts that give rise to international trade and investment flows. Grasping this reality helps to make clear just how silly it is for Americans to fret over the accounting artifact called “US trade deficits.”
“But,” someone might object, “because foreigners who hold US dollars do eventually intend to use those dollars to buy American goods, services, or assets, those dollars represent debts that Americans owe to foreigners. After all, dollars are claims on dollar-denominated goods, services, and assets. And so when foreigners hold US dollars, they hold claims on American stuff — meaning that for each US dollar foreigners currently hold, Americans are one-dollar in debt to foreigners.”
Although this objection is understandable — I encounter it often even from intelligent people committed to free trade — it’s mistaken. Holdings by foreigners of US dollars do not put Americans in hock to foreigners.
To see why foreign holdings of US dollars are not American debt, consider the following simple example. In March, the only international commerce that occurs is when Joe in Jacksonville buys $1 million worth of tomatoes from Mia in Mexico, and then Mia immediately uses this $1 million to buy $1 million worth of petroleum from Dave in Dallas. In this case, the US in March runs neither a trade deficit nor a trade surplus; the value of American exports equals the value of American imports. Protectionists breathe sighs of relief.
In April, however, although Joe in Jacksonville again buys $1 million worth of tomatoes from Mia in Mexico, Mia now holds on to all of her newly acquired US Federal Reserve Notes. As a result, the US in April runs a $1 million trade deficit. Protectionists emit wails of worry. Indeed, protectionists will insist that Americans have as a result of this trade deficit gone $1 million into debt to foreigners.
Yet this claim of increased indebtedness is mistaken. If Mia had actually loaned the $1 million to Americans — say, if Mia had purchased $1 million worth of US Treasuries – then this $1 million US trade deficit would indeed represent an additional $1 million of American indebtedness to foreigners. But Mia lends the dollars to no one; she holds them. (You might imagine that she stores the dollars in her underground safe in Mexico City.)
No American is obliged, as a result of Mia holding on to her US dollars, to pay to Mia anything, be it money or real goods and services. If Mia’s dollar holdings oblige no American to pay anything to her (or to anyone else), it cannot meaningfully be said that Mia’s dollar holdings are American debt owed to foreigners. It follows that the $1 million US trade deficit caused by Mia choosing to hold her $1 million US dollars does not increase Americans’ indebtedness.
This conclusion might be challenged by two possible objections. One is that US dollars, being notes issued by the Federal Reserve, are redeemable at the Fed. That is, the Fed is obliged to redeem Mia’s dollars should she present them to the Fed. And because the Fed is America’s central bank, Americans are indeed in debt to the tune of $1 million to foreigners as long as Mia holds $1 million US dollars.
Were America still on the gold standard, this challenge would have some merit. Under the gold standard, when someone presented the one million Federal Reserve Notes to the Fed, the Fed was obliged to hand over $1 million worth of gold in exchange. But America abandoned the gold standard in 1934. (Well, mostly abandoned it; US abandonment of the gold standard wasn’t complete until August 15, 1971, which is a story for another time.) If Mia in 2025 presents her one million Federal Reserve Notes to the Fed she will get in exchange one million Federal Reserve Notes. In effect, the Fed owes Mia nothing.
The second and more substantive possible challenge to the above conclusion goes like this: Because Mia can use her dollars to buy $1 million worth of goods, services, or assets from Americans, her dollar holdings represent $1 million worth of goods, services, or assets that Americans will turn over to a foreigner and, thus, not retain for themselves.
The key phrase in the previous sentence is “will turn over to a foreigner.” Were Mia’s dollar holdings actual debt, the phrase would instead have been “must turn over to a foreigner.” The difference here between “will” and “must” is crucial.
The simple fact that no American is obliged to turn over anything to Mia in exchange for her dollars means that no American can correctly be said to be in debt to foreigners. No legal or ethical duty would be infringed if every American refused to turn over anything to Mia in exchange for her dollars. If every American acted in this way, Mia would find herself holding lots of worthless paper, and she would have no legal or ethical recourse to restore what she once believed to be the purchasing power of her dollars.
Yet of course in reality Mia can successfully spend her dollars in the US to buy goods, services, or assets. Many Americans will be eager to acquire Mia’s dollars by turning over to her goods, services, or assets. Crucially, however, precisely because no American is legally (or ethically) obliged to sell anything to Mia, no American is in debt to Mia because of her dollar holdings. When Mia spends her dollars in America, each American with whom she deals is, as a result, made better off — and made better off not in the way that a debtor is made better off by repaying a debt.
Americans who sell goods, services, or assets to Mia are not retiring any debt that they’ve contracted in the past. Unlike a genuine debtor who would be made better off if his creditor said “Tell you what, don’t bother repaying me. Give me nothing,” Americans who sell to Mia would be made worse off if, just before the sales are completed, Mia were to say “Never mind, I don’t want to buy what you’re selling.” No American who sells to Mia is obliged to sell to Mia and, therefore, is made better off as a result of selling to Mia.
“But wait!,” someone might still object, “Mia’s dollar holdings give her the practical power to get $1 million worth of American goods, services, or assets — things that, if Mia didn’t have those dollars, would be available for purchase by Americans. The result is a loss to Americans.”
So it seems. But because any goods, services, or assets that Mia buys from Americans with her dollars were produced by Americans in the hope of being sold for top dollar, were Mia to lose her dollars — or were the government to prevent her from spending or investing her dollars in the US — some Americans in their roles as producers would suffer. Whatever ‘losses’ American consumers suffer as a result of Mia spending her dollars in America are more than offset by the gains of those Americans who sell their goods, services, or assets to Mia.
How do I know that the American sellers’ gains are greater than the alleged losses of American consumers? (I say “alleged losses of American consumers” because Mia’s spending her dollars causes no American to lose anything to which he or she is legally entitled.) Easy. No American buyers were willing to pay as much as Mia paid for the goods, services, or assets that she acquired from America. The value of what the American sellers sell to Mia is obviously greater than what any American was willing to pay for those goods, services, or assets. Perhaps, for example, no American was willing to accept less than 160,000 bushels of wheat in exchange for $1 million while Mia was willing to accept 159,900 bushels. The American sellers got more in exchange from selling to Mia than any American buyers were willing to give.
Language is important and influential. By calling foreign holdings of US dollars American “debt,” the impression is conveyed that those dollar holdings are a burden on Americans. And from this impression it’s a short if careless step to the conclusion that the US government should restrict Americans’ trade in order to protect Americans from creating for themselves such a burden. Yet this impression is false: foreign holdings of US dollars are in no way American debt.
