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Quick Thought Of The Week: Paradox

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What would we think if we saw a sign on the road that said, “Sign not in use”? Should we believe what the sign says?

Let’s try another one. A thief tells you that he will return your wallet if you correctly guess whether he will keep it or give it back to you.

These are two examples of paradoxes.

In other words, they are propositions that seems plausible but, in fact, they are illogical. That is because it contains two facts that are opposed to each other.

Both facts can’t exist at the same time.

The same thing is happening with the White House’s plan to cut its trade deficit by imposing trade tariffs on the rest of the world. Meanwhile, it also wants to be the reserve currency of the world.

The two things can’t happen at the same time. It is paradoxical.

Consider what happens when America buys $100 worth of goods from China. It pays for the purchases in US dollars. If China then buys $100 worth of American goods, then, voila! No trade deficit.

But it also means that China would have nothing in reserve. So, it buys less than $100 worth of goods from America and keeps the balance in US Treasuries. In other words, it lends the balance back to America.

Now increase that $100 by several orders of magnitude, and that is the size of America’s trillion-dollar paradox.

The upshot is that if America wants to be the world’s reserve currency, which it does, then it must run some sort of a trade deficit with not only China but also with the rest of the world. That is the price it must pay for being the world’s reserve currency.

Additionally, as the world’s reserve currency, the value of the US dollar is likely to be artificially inflated. Constant demand for the dollar will ensure that it is.

That poses another dilemma. An inflated dollar will make US goods and services less competitive, which could in turn exacerbate its trade deficit. Who would want to buy American-made cars, when Japanese cars are cheaper?

The problem of America’s trade deficit is intractable. It can persuade China and other countries to buy more goods to narrow the trade deficit….

…. but then the US dollar would no longer be the reserve currency of the world. That would open up a whole new can of world’s that neither America nor the rest of the world would want to contemplate.

Thankfully, that is not going to happen. So, America is stuck with a problem that even trade tariffs won’t solve.

A version of this article first appeared in Stock Advisor Gold and Stock Advisor Singapore.

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