US RECORDS RECORD TRADE GAP OF 66.1 BILLION NI SEPTEMBER 2005

MECHANICS OF INTERNATIONAL BALANCE-OF-PAYMENTS, OR WHY INTERNATIONAL ECONOMISTS ARE SEEN BY EVEN THEIR PET HAMSTERS AS BORING INDIVIDUALS

The US Commerce Department recently reported that the US Trade Gap widened to a record 66.1 billion dollars in September.[i] The gap for the previous month was 59.3 billion. The previous record was $60.4 set in February of 2005.

Imports of goods and services for September totaled 171.3 billion. US exports of goods and services were 105.2 billion. The trade gap deficit figure is the most commonly cited figure. But let us take a more global view and look at how international balance-of-payments matters are handled and how the US finances these almost perpetual trade deficits.

Just as the books of a business or an organization must be reconciled, international balance-of-payments must be reconciled between nations. Let’s use an example of business and how it relates to it customers and creditors and then we will use that example to explain international matters. This post will probably be a two-parter, so let’s lay out Part I today.

Lemon County Lead Sleds makes customized “chopper” motorcycles using Hogsome-Darlington engines. Lemon County had a few good years but has recently fallen on hard times. Sales have fallen and the cost of the parts to build the motorcycles have risen. In 2004, it sold 1 million dollars worth of motorcycles and towing services. However, the cost of parts for the Lemons was 1.2 million. (We will forget all about rent, labor, everything else.) Lemon will have to make up this .2 million dollar shortfall somehow. It has two basic choices.

YOU CAN'T LOSE MONEY FOR EVER-UNLESS YOU HAVE A FEMA CONTRACT

One way for Lemon to make up the .2 million dollar deficit is to dip into its bank account and pay the suppliers from earnings it has retained from its better days. This is a common way for a business to take care of a shortfall. Just as individuals dip into their savings to pay bills, businesses do the same thing.

Another way for Lemon to make up for the shortfall is to borrow the money to cover the .2 million dollar shortfall. Lemon might go to the bank and borrow the .2 million dollars. It the bank thought it that Lemon had good potential to turn profits in the future, it would likely loan Lemon the money. But there is another way for Lemon to borrow the money it needs. Ask its suppliers to provide the engines and other components on credit.

JUST GIVE US A LITTLE MORE TIME TO PAY THE BILL

It is common practice among businesses to provide goods and services on credit. When a business allows another organization to buy its products on credit, it is in effect loaning the purchaser the money to buy the goods and relies upon the promise of the buyer to pay for the goods in the future. The seller will recognize the debt from the buyer in its accounts receivable, and will often require payment in 30, 60, 90 days, or in some other time frame. Many businesses will charge the buyer interest on the debt if they take too long to pay the bill.

This is a fairly common commercial arrangement between companies. Let’s assume that Lemon buys all of its motorcycle frames from one company, Fark Frame. Fark Frame is the only motorcycle company to make its frames out of lead. And let’s further assume that Fark Frames has no other customer for its lead frames. If it loses Lemon County Lead Sleds, Fark Frame is out of business. If Lemon County needs to buy frames on credit to stay in business, Fark will have two choices. Go out of business or loan money (extend credit) to Lemon County to buy Fark Frames.

And if Lemon expects to stay in business iit must finance its loss, or deficit, in some fashion. Many readers can see that the relationship between Fark Frames and Lemon County looks a little but like the relationship between the US and China.

See you tomorrow and we will up the stakes and up the deficits.

WE ONLY SHIP PREPAID OR C.O.D IN THE DESERT OF THE REAL!

[i] http://www.bea.gov/bea/newsrel/tradnewsrelease.htm