Monday, January 5, 2015

Exploring the Mechanics of Foreign Trade

Brian Romanchuk has an interesting post on JCB's and demographics. His article provided impetus for me to put into graphical form what I think are the mechanical aspects of trade with Japan. 

The chart below illustrates what seem to be the mechanics of international trade. There is nothing difficult here. Cars are a place holder for any product handled in international trade. The mechanics of unbalanced trade seem to result in large bank accounts in each of trading countries.
Unbalanced foreign trade results in large bank accounts.
Products cross the boarders of countries, currencies are much less mobile. Each country (except the Euro Zone) usually has it's own currency. The currency has a hard-to-determine-value in other countries. As a result of the difficulty of exchanging currencies, sales into foreign countries tend to result in ownership of bank accounts in the foreign countries. If trade is unbalanced over many years, the accounts owned by one nation but located in another nation can become very large. A current example is the accounts of Japan and China in the USA where values have reached $1222 and $1253 Billion respectively. 

If the illustration displays the mechanics of unbalanced inter-currency trade correctly, the producing country is trading physical products in exchange for bank accounts. How can the bank accounts be used?

Both Japan and China could go shopping in the USA. The interesting thing is that neither really wants to do that. Why might that be? One reason is certainly that products are less expensive in Japan and China so why would either country want to shop in the USA?  Raw materials and agricultural products would be exceptions because both countries have resource shortages. 

We can examine resources and agriculture further. Both of these product baskets are produced on a world wide scale in competitive markets. The USA has high labor cost which tends to make it a supplier of last resort. Stated another way, Japan and China will buy from the USA when the other suppliers are sold out. 

So what should the trading countries do? Well, first, what is the problem? One worry would be that the bank accounts could be lost to inflation, which would result in a long term very unequal labor exchange. A bigger worry is that trade patterns might change, resulting in less work (jobs) for one trader and more work for the other. Or maybe there is nothing to worry about.

This post will close by noticing that one result of unbalance trade is increasing bank accounts in both trading currencies. The unbalanced trade could not occur unless both currencies accepted the unbalance no matter if the currency ownership is private or government.