The faulty logic of mercantilism

If you look at the U.S. current account balance … we are ceding about $450 billion of our wealth to mostly Southeast Asia and a little bit to Mexico,” Kyle Bass, founder of Hayman Capital Management, told the Fox Business Channel.

If you are looking for evidence to support the fact that just because you’re successful in business or finance doesn’t mean you understand the first thing about economics, look no further than Bass, a successful hedge fund manager. In this interview on the Fox Business Channel, he reached all the way back to the 1600s and the pre-Adam Smith days of economics. It was a time when mercantilism dominated thinking about trade policy and trade deficits were associated with a loss of national wealth. When Adam Smith published his appropriately titled “Wealth of Nations” in 1776, his main purpose was, in large part, to dispel the myths of mercantilism, apparently fully embraced in 2018 by Bass. (As an aside I find it unfortunate his interviewer, Fox Business News reporter and analyst Maria Bartiromo, seemed to buy into Bass’s antiquated views and left them unchallenged.

According to well-known historians of economic thought Robert Ekelund and Robert Hebert, the basic principles of mercantilism were laid out in 1684 and included as four of their most important tenets that:

— “All exports of gold and silver be prohibited and all domestic money be kept in circulation [domestically]”

— “All imports of foreign goods be discouraged as much as possible.”

— “That opportunities be constantly sought for selling a country’s surplus manufactures to foreigners.”

— “no importation be allowed if such goods are sufficiently and suitably supplied at home.”

So, what can we distill from this? It seems clear that for mercantilists, both old and new, money is wealth. Therefore, a country obtains wealth by selling the goods and services it produces to other countries in exchange for money, thereby making the purchasing country poorer by the amount of money it pays for the goods and services it’s purchasing. The bottom line is that for mercantilists, exports are good — money flows in, and goods flow out — and imports are bad — money flows out, and goods flow in.

Modern-day mercantilists like Bass and, unfortunately, President Trump on the Right and Bernie Sanders on the Left, are being true to their intellectual roots. Because a trade deficit, by definition, implies a net outflow of dollars, according to both 17th and 21st century mercantilists, it equates to a loss of wealth to the nation. To the mercantilist, a trade made internationally by Americans can only be wealth-enhancing to the United States if the American making the trade is the seller and not the buyer. This is why it is so important that purchases of goods from foreign countries be, at least, balanced out by sales.

From this perspective, those who we traditionally refer to as our trading partners aren’t partners in any true sense of the word. To the extent that they sell us more products than we sell them, as measured in net money outflows, they are adversaries whose gain is our loss.

Apparently, this is how Bass and other modern-day mercantilists understand the world. Rather than seeing voluntary trade similar to how the individual trader sees it, as being win-win regardless of whether you are on the goods or money side of the exchange, trade is seen as zero or even negative-sum, i.e., a win-lose. Because money is wealth, as Bass implies, those who are giving up dollars for cars, computers, food, clothing, etc. are unwitting victims. And while those people see themselves as being better off as a result of trading away their money, whose only value to them lies in the fact that eventually it can be exchanged for actual goods and services, the mercantilist sees only the loss of currency. This leads to the bizarre perspective that while all the individual buyers of foreign-made products see themselves as better off, and the country actually has more valuable goods and services than it otherwise would, the nation’s wealth is reduced.

This is the anti-logic that was successfully refuted in 1776 by Adam Smith and subsequently rejected by nearly the entire economics profession. But unfortunately, bad ideas rarely die, they just hibernate to be poked and woken up by politicians and those — as with the case of Bass — who think that their expertise in making money transfers to an actual understanding of economics.

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Roy Cordato is vice president for Research and resident scholar at the John Locke Foundation.

Roy Cordato is vice president for Research and resident scholar at the John Locke Foundation.