The Innocent Fraud of the Trade Deficit: Who’s Funding Whom?


US consumers need to borrow $billions from foreigners.


US consumers are funding $billions in foreign savings.

While the media continuously bemoans an assumed US dependence on foreign capital, a recap of the actual transactions involved reveals the reverse.

Let’s begin with the example of US consumer buying a German car.

If the consumer pays cash for it, the consumer’s checking account in a US bank is debited and the German carmaker’s account is credited, thereby increasing foreign savings of USD financial assets. Total deposits in the US banking system remain unchanged.

If the consumer borrows to buy the car, the bank makes a loan to the consumer, which results in a loan on the asset side of the bank’s balance sheet and a new deposit on the liability side (loans create deposits). After the car is paid for the German car company has the new bank deposit. Consumer borrowing increased total bank deposits and funded foreign savings of USD.

That’s what the finance behind the trade gap is all about – foreigners desire to net save USD financial assets and sell goods and services to the US to obtain those assets.

Following the above transaction the foreign holder of USD bank deposits may instead desire to purchase US Treasury securities. At the time of purchase, the seller of the Treasury security becomes the new holder of the bank deposit, and the foreigner the new holder of the Treasury security. (If the foreigner buys securities directly from the Treasury the result is the same.)

The US government is now said to have foreign creditors, and the US is said to be a debtor nation.

While this is true as defined, a look past the rhetoric at what the US government actually owes the holder of the Treasury security is revealing. What the government promises is that at maturity the foreigner’s security account at the Fed will be debited, and his bank’s reserve account at the Fed will be credited for the balance due.

In other words, the US government’s promise is only that a non-interest bearing reserve balance will be substituted for an interest bearing Treasury security. This is not a potential source of financial stress for the government.

Warren Mosler

February, 2004

57 Responses to The Innocent Fraud of the Trade Deficit: Who’s Funding Whom?

  1. Ben says:

    Dear Warren,

    if the foreign “carmaker” has only an account at a foreign bank, and the foreigners hoard dollars, but do not buy US assets, would then a continuous trade deficit not lead to a continous loss of reserves of the US banking system? And is this not one of the real problems of Greece, Spain and Italy, that their banks lose reserves because of a continuos trade deficit, and the lack of buying of assets of these countries?


    no, reserves can’t leave the banking system. they just go from bank to bank.
    (they are aka ‘clearing balances’)

    any bank can lose reserves, but not the banking system as a whole

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  3. Matthew Arnold says:

    Is it also a way of maintaining a low exchange rate? I mean by holding $US assets vs. transferring them to the holder’s country…

  4. Haku says:


    Thanks. I had already read your 7DIF text, thats why i posted that comment.

    For instance, your 2nd DIF is wrong. It is correct only at a global level, not at a nations level. Thats called fallacy of composition. Your children will not pay you back in time, they will pay back to another country’s current children.

    For example, you wrote:

    “When our children
    build 15 million cars per year 20 years from now, will they
    have to send them back in time to 2008 to pay off their debt?”

    No, they will have to send them back to China or some other country you are currently borrowing from.

    “Our children won’t and can’t pay us
    back for anything we leave them, even if they wanted to.”

    They wont pay you back, they will pay someone else’s children back.

    “U.S. government could legally impose all
    kinds of taxes on anything foreigners wish to buy from us”

    No, you could only do that against a small country, not against China, your main lender. As soon as they realize you are avoiding payments, i doubt they will just take it.

    I think the main issue is, a floating currency only means the value is shifted at a specific point in time, so everything else is shifted as well, but the same principles apply. No monetary trick can appear goods and services out of nothing. That even defies the laws of physics. Those goods and services you consume are being produced by someone, and that someone else will demand goods and services back, either now, or in the future.

    Cheers :)


    your last paragraph is the correct one.

    but think about what the option of the holders of dollar balances at the fed are.

    they can either spend them or not spend them. that’s all.

    spending takes place at market prices from willing sellers.

    and their balances are subject to taxation.

    while possible, i’ve yet to see a nation invaded because it raised taxes on interest income.

    and greece just, for all practical purposes, taxed away 100 billion in outstanding debt with no hint of military consequences.

    i’ve yet to see a nation invaded because it’s currency depreciated.

    japan has been sending us 2 million cars a year for over 50 years and piling up the dollars,
    which would buy back only a small fraction of that if they attempted to buy cars from the US,
    and that’s without us taking any specific action to stop them from buying our cars.
    in fact, we’re trying to encourage US exports.


    Haku Reply:


    I think you are missing the point. The dollar is only worthy as long as you can actually exchange it for real goods and services.

    Say China wants to exchange their trillion dollars for real goods. Then they realiza that they cannot really buy much with it. Thats when the dollar becomes worthless. It loses value. Now people see the dollar devaluating, so they try to exchange it for real goods before it loses more value, but nobody wants dollars anymore because its losing value. So hyperinflation kicks in.

    Notice if the dollar devaluates you wont be able to import much goods, because nobody will acept dollars. So you will have to produce your own goods. But you cannot reestructure your whole economy in a short time.

    I dont believe military will be the first consequence. I think the chinese know that they will never get paid (in real goods), thats why they are pushing for a new world currency. That is obviosly not good for USA. Now if someone oposes that, things might blow up.

    I think the best thing you can do is gradually reestructure your economy in order to actually produce more real goods, becase thats what gives value to your currency. But it might be too late. As soon as investors and lenders realize they are losing value, things will get ugly, not just for USA, but for the whole world.

    Also i dont belive im worrying about the wrong thing, i have some savings that i would lose if your currency crashes.

    Neil Wilson Reply:


    “Say China wants to exchange their trillion dollars for real goods. Then they realiza that they cannot really buy much with it. ”

    Say they don’t.

    Primarily because if they do, then the US won’t be able to buy any Chinese goods with it.

    Leading to economic collapse in China.

    The problem is analysing China as though it is outside the system. It isn’t. It is in a symbiotic relationship with the US and the rest of the world.

    Any action it takes will reflect back on its economy. It cannot act in isolation.


    value and worth are all about prices


    you are saying that prices going up causes prices to go up.

    read ‘the 7 deadly innocent frauds’ yet?

    Neil Wilson Reply:


    In other words deal with the issue when its actually a problem.

    Rather than trying to pretend you can predict the future when you can’t.

    Do you lay awake at night worrying if the Methane Clathrates in the pacific are about to melt?

    If not then I would suggest you are worrying about the wrong thing.


    or, not reason to kill the goose laying golden eggs because you think it might fly away some day

    Haku Reply:

    @Neil Wilson,

    That would be reasonable except when the actions you take are making the issue worse. In such case its better to take the right actions instead of let it go worse.

    Neil Wilson Reply:


    There is no evidence there is an issue, so how can you be making it worse?

    Fear is not evidence.

  5. Haku says:

    By the way, sorry if this wasnt the best thread to comment that. I just read several of your texts, and to my understand, you are pretending there are no consequences of borrowing and debt increase.

    I might concede, tough, that theres a monetary offset in the zero deficit point, but you seem to be implying more than that in your writings.


    again, please read ‘the 7 deadly innocent frauds’ thanks

  6. Haku says:

    I am no expert in economy, but i have a feeling you are just reasoning in circles. Im sure some economist will catch your flaw.

    USA is, indeed, borrowing from China. And China will, sooner or later, want you to pay.

    Dont forget the human factor. If you try to fool them, they will get upset. Im pretty sure you dont want to upset China at this point, much less in 10 years.

    They might not even need to go to war, they could simply use their political power to get what they believe belong to them.

    So be careful, debt is debt. You cant borrow forever. Chinese are not stupid.


    please read (reread?) ‘the 7 deadly innocent frauds’ on this website

  7. zanon says:

    they also do it because they do not trust their own currency (like peso)

  8. rodneyrondeaujr says:

    Correct me if I am wrong but I beleive foreigners want to net save U

    S assets because they need them to buy oil. Its probably not the only reason.


    some, like china, do it to support their exports

    John O'Connell Reply:


    And why would they want to “support their exports”, if exports are a cost?

    Because net exports are a positive contributor to GDP (C+I+G+(X-M)). A country that net exports accumulates financial assets (= “wealth”).

    GDP and wealth are considered to be goood things.

    “You can never be too rich or too thin” – Wallis Simpson

    A country that net imports has higher consumption (=standard of living).

    The trade balance is worldwide, but considering just for a moment the US and China in isolation, at some point perhaps the Chinese will have accumulated “enough wealth”, and may desire to raise their standard of living, by becoming a net importer. I.e., by buying lots of US exports, or maybe even by buying things that we have never before exported, or that can’t be exported, like farmland or factories or amusement parks.

    The increased demand would cause rising prices, perhaps even inflation if we are already at full employment (and government fails to run an offsetting surplus). If the US becomes a net exporter, then we sacrifice standard of living and accumulate financial assets. (This is what we did from the time of Columbus until the 1970’s or so, and I have to wonder if that is not why we were able to rise to the status of “superpower” in the last century.)

    The Chinese might send all the food they grow on their farmland to China, and use the profits from their factories and amusement parks to buy even more American-made goods.

    Is exporting, and accumulating financial assets over a period of decades, the thing that enables a country to become a net importer, and live the good life? Can a poor country run a trade deficit and become rich? Why is post-war (West) Germany a strong economy, and others in Europe relatively weaker? Is it because of their decades of net exports?


    yes, net exporting might allow you to net import in the future. but you are at the mercy of the place you want to subsequently import from. for example, if you were japan, and got a note from the fed that their computer went down and all accounting records have been lost, and you no longer have a balance in your fed accounts, what can you do?

    a nation can only run a trade deficit if other nations want to net export to that nation. it’s up to the other guys, not the importer. however today, most nations want to next export, and most any nation could take advantage of that value.

    it’s all about how you define strong and weak, along with your success in sustaining domestic employment and output.

  9. Tom says:

    What are the main reasons for such a strong desire for foreigners to save in USD and export to the US? Is it mostly because of small domestic demand/purchasing power, so they need to export to avoid supplies going no where? Or is it because the US is in a very stable position? Or is it another reason, or a combo of a lot? Ive been curious as to why nations are so willing to be such heavy net exporters to us.

  10. Laurenz Seiger says:

    Dear Warren, much respect for your work, but I still have many questions. For example, what would happen if foreigners would decide that they want to trade their treasuries against… let’s say US land?


    foreigners are free to buy US land, and they do buy quite a bit of it.

    fortunately they generally don’t dig it up and take it home!


    Laurenz Seiger Reply:

    Thank you Warren for your quick answer, I really appreciate that. From the perspective of a world citizen, it doesn’t matter who owns which assets.

    But if I were the president of the US(don’t worry, i will not run for office, I’m austrian ;) ) I would try to encourage US population to acquire assets from the rest of the world. What are your thoughts?

    Just in case the dollar would lose some of its value against other currencies, it would be good to have some income stream from outside. I guess investments from US corporation all over the world and other portfolio investments are kind of achieving this goal, unintentionally of course.


    Tom Hickey Reply:

    Lots of US capital in emerging markets. That’s where the growth is coming from.


    sounds like a plan but the risk is that the income from rest of world can get cut off by them and, more important, that they keep it from translating into improved real terms of trade at the macro level

    beowulf Reply:


    Any county commission is free to pile up property taxes on absentee landlords who can’t vote (that’s the point of homestead exemptions). And if a foreign national attempts to buy property and the US Gov thinks this could threaten national security, it always has the right to block the sale– or just condemn the land for a new VA hospital, what luck!.

    Tom Hickey Reply:

    The price of RE would go up. The Japanese tried that in the 80s and got burnt.

    Laurenz Seiger Reply:

    That was also my first thought. Doesn’t that also mean US citizens also have to pay more for RE as long as this buying goes on?
    Lets picture a radical, very very very unlikely scenario: what if foreign holders of US financial assets are buying all food available in the US and burn it ( I know its stupid, but still), so that for 1 year there is no food left? (If that happens, I hope I’m a farm owner :) )

    And lets assume that this nominal dissaving from foreigners is not matched by growing nominal saving my americans, would that mean higher taxes and higher prices for some time?

    Tom Hickey Reply:

    Free trade and free capital flow definitely affect a nation’s economy.

    Foreigners can bid up prices, of course. The US is bidding up prices in the emerging nations right now as capital flows out of the US into EM’s in anticipation of higher growth there than at home.

    The sectoral balance approach would say that higher exports means that taxes can be lower, if private domestic savings remain constant. Demand leakage comes from taxes, saving, and imports, so with increasing exports, demand leakage to taxes is offset with saving the same.


    yes, higher prices.

    and, as before, exports are real costs that reduce standards of living/real terms of trade

    beowulf Reply:

    “what if foreign holders of US financial assets are buying all food available in the US and burn it ( I know its stupid, but still), so that for 1 year there is no food left?”

    And are the foreign holders of US financial assets sending an army to collect “all foods available in the US” and do they intend to arrive by sea or by air? They’d have to shoot their way in because they certainly won’t have an enforceable contract right to do so thanks to our old friend the Defense Production Act (the law that I noted the other day grants the President broad lending powers), which also states:
    The President is hereby authorized… to allocate materials, services, and facilities in such manner, upon such conditions, and to such extent as he shall deem necessary or appropriate to promote the national defense.—-000-.html

  11. Norme says:

    I used to agree, “but not until after the export boom” was the ‘unstated’ purpose of QE2 (can’t call it QE ‘lite’ anymore, it’s anything but.) To drive down treasury yields and demand for the dollar (debasing the dollar) while the government cuts due to a decline in foreign debt funding.

    Interestingly, if buying treasuries only expands no interest reserves and supports a low overnight rate, then QE2 will simply boost liquidity…and a dollar carry trade. The dollar carry should debase the dollar a bit, I believe. It kept the Yen above 100 for years.


    not much evidence the yen carry trade did much material damage to the yen?

    Mario Reply:


    not so sure what you mean by “material damage” but the yen carry did keep it stuck ranging around $90 for about 15 years. Now that the US is on the carry trade scene, the yen seems to be unwinding upwards finally, much to the dismay of their exporting business I’m sure…and of course “pegging” their dollar to the US is not exactly the most hospitable thing to do considering all the China upset, even though we all know Japan would like to do that (the earthquake was their latest excuse for such a moment as you posted about at the time).

    I think you can definitely say that the carry trade clearly effected the yen nominally, but I suspect by “material damage” you are referring to actual CPI/PPI figures I don’t know?


    i seem to remember it in the 120’s until Paulson took them on for ‘currency manipulation?’

    Mario Reply:


    Yes on the USD/JPY that’s correct. I was referring to $90 on the yen chart alone. I wasn’t referring to the USD/JPY. I should have clarified that. We’re saying the same thing.

  12. kunal says:

    That is the most absurd economic thought I have come across. Mosler needs to get his head checked.

    Norme Reply:

    Kunal, when I first read some of Mosler’s work, I hit the ceiling. However, careful study does seem to enlighten, if only the mechanics of it all. It’s a hard coin to swallow for a hard currency guy. The last thing we want is a pure fiat currency, but that appears to be what we have. I’d recommend studying MMT, if only to know thy enemy.

  13. jorge R L says:

    “If foriegners are getting interest on their deposits then the foriegn entities will be getting interest and will have a claim on some US assets…right?”…

    WRONG!!!! they will get interest, which means more $. NO CLAIMS ON ANY ASSETS! .They will have an option to SPEND those $ with americans who may or may not want to sell US assets, depending on price.

    The option to sell US assets is the sellers option NOT the CLAIM of some foreigner who holds $.

  14. Warren Mosler says:

    As they pile up $US financial assets they can certainly decide to buy real goods and services from any willing sellers at ‘market’ prices.

    I’m not saying trade deficits are ‘benign,’ I’m saying that imports are real benefits, and there is no funding issue for govts. spending their own currencies. Nor are we in anyway dependent on foreigners lending to us in our own currency.

    I’m also saying when you see Clinton and Obama kissing up to China because they think we need them to buy our securities they have it all wrong.

    Joe Eagar Reply:

    While its true inflation (which usually disproves all of this) is at low levels, you are forgetting a vital correspondent, one vital to foreign relations:

    The exchange rate.

    Governments are fiscally restrained, not because of a fear of inflation but because of exchange rates. Altering the exchange rate alters the allocation of resources and a nations terms of trade. This can and has led to many wars throughout history.

    Increasing reserves does two things. With a slack economy this will push down exchange rates, leading to an export boom. When things start picking up steam, inflation will push real interest rates back up; this is why the Fed has dedicated so much time developing new tools to prevent that (but not until after the export boom).

    Unbalancing trade is immoral; it creates creditors and debtors regardless of the will of each nations people. The conflict it creates is very harmful. Of course, our case is different; we’ve allowed ourselves to be taken advantage off, and payback is actually mutually beneficial in this case (balanced trade lifts all boats; unbalanced trade does not).


    increasing reserves doesn’t alter exchange rates per se.

    Mario Reply:

    @Joe Eagar,

    Increasing reserves does two things. With a slack economy this will push down exchange rates, leading to an export boom.

    why an “export boom”?

    Unbalancing trade is immorall; it creates creditors and debtors regardless of the will of each nations people.

    so you are saying that we must export to China as much as import from China? What is likelihood in this world today and the matrix of possibilities and scenarios that such a “balanced world” would ever be able to sustain itself? It seems very unlikely if not impossible from an operational and controlled standpoint. It’s almost like attempting to replicate the barter system again but with a currency attached to it instead? Why not just balance out the external sector either way through proper sectoral balances in your own individual nation as a sovereign currency monopolist?


    increasing reserves per se doesn’t alter exchange rates.

    John O'Connell Reply:

    @Warren Mosler,

    “I’m not saying trade deficits are ‘benign,’”


    What are the hazards of the trade deficit? In a floating exchange rate regime, is it the constant depreciation of the dollar as we have seen? How does this impact other things in the economy? Can it continue indefinitely? Will it tend to reverse itself at some point, like a cyclical phenomenon?


    the biggest risk is that it ends. always sad when the goose laying the golden eggs dies. see the chapter in the 7dif, thanks

    John O'Connell Reply:


    So, why is it not benign? As long as it continues.

    And why would it end, if left to its own devices? (i.e., we don’t resurrect Smoot-Hawley or something similar).


    Yes, it’s just an accounting and not an imbalance

    And need not end

    SteveK9 Reply:


    Isn’t the risk what you alluded to above: The ‘Chinese’ may buy real assets, factories, etc. This would seem to be a negative. We wouldn’t want another country owning all the real assets here. The solution seems to be … we don’t let them. They are free to buy goods and services, but not real assets.

  15. Marcello says:


    If foriegners are getting interest on their deposits then the foriegn entities will be getting interest and will have a claim on some US assets…right?

    So it seems like its not entirely true that the deficit is benign.

    Craig Austin Reply:

    Don’t fear folks Dollar Monopoly is here. Fighting the worlds injustices one blog post at a time. So let’s see here, yes Mr Mosler is, in fact, correct.

    Just as every asset has a corresponding liability in accounting, the currency issuer’s debt is dollar for dollar equal to the currency user’s savings.All monetary operations by the issuer are derived in government liabilities. All liabilities by the issuer create a corresponding asset for the currency user as a matter of accounting. The issuer’s debt is a digital resource – a digital account corresponding to all the savings of currency users’ in banknotes, deposits, and treasuries.

    Currency issuers do not “borrow” money, they create it. The proper way to think of it is that issuers create the currency that users either save or spend. In other words, China does not lend to the US government. China saves in the currency the US government produces. This is not a theory this is double entry accounting.

    Hope that helps. Hate to cut and run but I got to do some laundry back at the Dollar Monopoly house

    beowulf Reply:

    @Craig Austin,

    So let’s see here, yes Mr Mosler is, in fact, correct.

    You and Warren are going to get along just fine.

    Mario Reply:

    @Craig Austin,

    love it DM!! We should see if you can’t get rights to the Monopoly Man logo…it’d be perfect!! LOL :o)