While some countries still enact mercantilist policies that directly affect the relative prices of traded goods in ways that David Ricardo would have understood two hundred years ago, in today’s global trading environment, persistent trade surpluses are usually caused by distortions in income distribution that force up savings rates. These high savings rates, which are almost always mistakenly attributed to a country’s thrifty habits – just as low US savings rate are foolishly attributed to spendthrift American habits – create demand deficiencies that must be resolved with trade surpluses.
For most of modern history, however, it wasn’t this way. Trade imbalances reflected mainly the relative costs of producing goods. If British textile manufacturers could produce and ship textiles to France at a much lower cost than French producers could manage, for example, England would run a trade surplus in textiles with France, and bankers would finance the trade imbalances. During this time, 90 percent of all international financial transactions in London consisted of trade finance. A country’s trade balance consisted of the sum of all its various bilateral trade imbalances, and net flows of capital were primarily driven by trade finance.
This post was published at FinancialSense on 04/03/2017.