ALL FINANCIAL CRISES ARE CRISES OF SHORT TERM DEBT.

John "Grumpy Economist" Cochrane opens an essay on tariffs, saving, and investment with a candidate Friday short take:  "I haven’t written much about tariffs, because so many other economists are doing such a great job. Tariffs are easy: The right answer is unilateral free trade. Tariffs are hard: The rest is explaining why 100 objections are wrong."

The focus of his essay is on the financial, rather than the material.

One aspect is less clear than the others: the whole business about saving, investment, “reserve currency” and so forth. Most economists reacted in horror at CEA chair Stephen Miran’s essay claiming that US reserve currency status — that we can print money, send it abroad and other countries work hard and send us stuff in return — is a burden for the US. Actually there is a kernel of logic here, and a great danger, though tariffs will do absolutely nothing to rectify the situation at least without huge economic cost.

The essay clarifies a number of points apart from my observation,

Let us also note that it is folly to expect trade flows involving a country whose currency is a reserve currency for international settlements to balance.  Somebody who does not live in that country has to obtain that reserve currency somehow, which means selling goods to obtain the currency, either to hold qua currency ... or to hold securities denominated in that currency.

of last week.  The "situation" Professor Cochrane calls attention to, though, is that people in other countries can choose whether to hold dollars and dollar-denominated securities, or not.

Something similar has happened to the US, on a grander scale and with nobody standing in the wings to bail us out. That’s the danger.

For various reasons, many countries around the world including China wanted to save. For various reasons, additional domestic investment did not seem like a good idea. Chinese savers did not want even more Chinese factories. One of many reasons for this saving (more later, but it helps to make the story) is that China is aging and has little safety net, so its middle age workers want to put money aside, to withdraw when they get old. So, those savers chose to invest in the US. China already does a huge amount of domestic investment, including a suspicious number of bridges to nowhere and empty apartments. Maybe they just ran out of opportunities.

Before he gets to the lesson, he offers four fundamentals of economic analysis.

1.  The capital and current account must add up.  (That renders Our President's hopes of balancing imports with exports a forlorn hope; that's not germane to today's lesson.)
2.  Money is a veil. Understand the underlying movement of goods and services.  (In order for China to accumulate dollars, somebody must send dollars to China, generally for goods.)
   
3.  The overall trade (goods and services) deficit equals the difference between savings and investment plus the government deficit.
4.  Separate real from nominal.

Then comes the lesson, and it's sobering.

Now comes the Greek trouble, the hubris, the pride before the fall. The US reacted to the offer by other countries to borrow from them (sell them assets) at very low interest rates, not by building factories, but going on a consumption binge. Just as Greece had done. Most of that is due to the actions of the federal government. The total trade deficit is about $1 trillion. The US budget deficit is about $1.3 trillion. All of that extra saving is going to the federal government. And the federal government is not building a trillion dollars a year of productive investment with the money. The federal government is, by and large, sending checks to its citizens to support current consumption. The federal government saw an amazing opportunity to borrow cheaply, sometimes even at negative real rates of interest. Borrow it did, and sent checks to happy voters.

The Chinese are not, it turns out, financing their retirement from the profits of a new generation of factories. They are hoping to finance their retirement from the US federal government’s willingness to tax its citizens in excess of spending, some day in the far future, in order to reverse the whole process and put stuff back on boats to send to China.

The hard reality of debt is you have to pay it back someday. Or default, which causes lots of trouble. The hard reality of trade deficits/capital surpluses is that foreigners also expect to be paid back — for Americans to work hard to put stuff on boats in return for getting our own paper back. This is what mercantilists desire. Be careful what you wish for, you just might get it. Or we default/inflate away the debt, which will have its own catastrophic implications. If I were China though, I would be very worried about whether I’m actually going to get paid.

Other holders of dollar-denominated debt can have the same fears.  What follows will not be pleasant.  "In sum, spurred on by the federal government (in many ways), the US borrowed a huge amount from foreigners at very low rates, and went on a consumption binge. Sooner or later we have to pay it back, or we go though the wrenching adjustment of a debt crisis."  There are plenty of people to blame for the situation (we have met the enemy and he is us?) and tariffs "are not likely to fix any of this."

Buckle in.