One of the best decisions I made in the early 1990s was to get Herb Stein to do a piece on the balance of payments for The Concise Encyclopedia of Economics, which was then The Fortune Encyclopedia of Economics. His first two paragraphs are still beautiful:
Few subjects in economics have caused so much confusion—and so much groundless fear—in the past four hundred years as the thought that a country might have a deficit in its balance of payments. This fear is groundless for two reasons: (1) there never is a deficit, and (2) it would not necessarily hurt anything if there was one.
The balance-of-payments accounts of a country record the payments and receipts of the residents of the country in their transactions with residents of other countries. If all transactions are included, the payments and receipts of each country are, and must be, equal. Any apparent inequality simply leaves one country acquiring assets in the others. For example, if Americans buy automobiles from Japan, and have no other transactions with Japan, the Japanese must end up holding dollars, which they may hold in the form of bank deposits in the United States or in some other U.S. investment. The payments Americans make to Japan for automobiles are balanced by the payments Japanese make to U.S. individuals and institutions, including banks, for the acquisition of dollar assets. Put another way, Japan sold the United States automobiles, and the United States sold Japan dollars or dollar-denominated assets such as treasury bills and New York office buildings.
Herb died in 1999 and so, when I did the second edition of the Encyclopedia earlier this century, I, with the help of Kevin Hoover and the late Mack Ott, updated his numbers and added the last two paragraphs:
These same concerns surfaced again in the late 1990s and early 2000s as the current account went from a surplus of $4 billion in 1991 to a deficit of $666 billion in 2004. The increase in the current account deficit account, just as in the 1980s, was accompanied by an almost equal increase in the deficit in goods. Interestingly, the current account surpluses of 1981 and 1991 both occurred in the midst of a U.S. recession, and the large deficits occurred during U.S. economic expansions. This makes sense because U.S. imports are highly sensitive to U.S. economic conditions, falling more than proportionally when U.S. GDP falls and rising more than proportionally when U.S. GDP rises. Just as in the 1980s, U.S. employment expanded, with the U.S. economy adding more than twenty-one million jobs between 1991 and 2004. Also, employment as a percentage of population rose from 61.7 percent in 1991 to 64.4 percent in 2000 and, although it fell to 62.3 percent in 2004, was still modestly above its 1991 level.
How about the issue of foreign ownership? By the end of 2003, Americans owned assets abroad valued at market prices of $7.86 trillion, while foreigners owned U.S. assets valued at market prices of $10.52 trillion. The net international investment position of the United States, therefore, was $2.66 trillion. This was only 8.5 percent of the U.S. capital stock.
By the way, Herb was my boss at the Council of Economic Advisers in the summer of 1973, when I was a summer intern fresh off my first year as a Ph.D. student at UCLA. He was one of the two best bosses I ever had. (The other was Bill Meckling, dean of the Graduate School of Management at the University of Rochester.)
