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Seven Ways to Think Differently about Trade Deficits

April 5, 2017 6 minute Read by Matthew Rooney
Some think America is a chump because our market is open while we let other countries limit our access to their markets. Luckily for America, this way of looking at our trade balance is almost entirely wrong.

To hear some people tell it, America’s trade deficit shows that our economy is failing.  By this logic, America is a chump because our market is open while we let other countries limit our access to their markets.

Luckily for America, this way of looking at our trade balance is almost entirely wrong.

Trade is about people, not countries

To understand why, it is important to recall that trade is about people, not countries.  If an American goes car shopping and chooses a Kia instead of a Ford because she believes that her money is better spent that way, who are we to tell her she has made a mistake?  If Ford buys a wiring assembly in Mexico that enables it to sell its car at a price that gets that sale, is that a good thing for America or a bad thing?

Dollars that flow out, flow back in

But doesn’t a trade deficit mean that money is flowing out of our economy, making us poorer and enriching our trading partners?

This is a tempting logic, but it’s misleading.  

To understand why, it’s important to understand that a country’s balance of payments, which summarizes all transactions between its citizens and the rest of the world, is like a corporate balance sheet, where assets and liabilities are equal and add to zero.  

However, in the case of the balance of payments, we don’t talk about assets and liabilities. Rather, we talk about short-term transactions (aka the “current account”) and long-term transactions (aka the “capital account”).  

This means that a current account deficit is the flip side of a capital account surplus. Dollars that flow out to buy goods and services turn around and flow back in as foreigners buy goods and services and invest in the U.S. – either way, employing Americans.   

From this perspective, a trade deficit is not an indicator of national economic failure. On the contrary, it is more like an indicator of success:  it means the U.S. has a thriving economy that is an attractive place to do business and produces abundant wealth.  

When people buy our dollars, it's like getting a loan

However, this doesn't mean a trade deficit is not important. 

For one thing, some people want dollars because it is the global standard for value.  As a result, dollars circulate outside the U.S. economy for reasons unrelated to American goods and services.  

This can reduce employment in the U.S. as foreigners keep the dollars they earn in trade rather than spending or investing them in the U.S.  This is harmful to American workers, of course, but the benefit to the United States is significant.  

Think about it:  it costs us about 14.3 cents to print a $100 bill, but foreigners will happily give us $100 worth of stuff in exchange for it.  It’s a type of free loan.  We should think long and hard before we give up this position.

Currency manipulation is ultimately self-defeating

A related factor is currency manipulation by governments.  Sometimes, governments will try to promote exports by using their own currency to buy dollars, bidding the dollar’s value up and depressing the value of their own currency.  

A policy like this can boost employment for some time, but it is ultimately self-defeating. Driving down the value of your currency eventually causes inflation. In turn, that leads to financial instability, interest rate increases, recession – and unemployment.

Trade deficits can encourage workers to get retrained

More importantly, the international trade and payments cycle is not instantaneous. Jobs are cut here and created there, affecting communities and workers differently. 

As a result, a trade deficit may well require a policy response. The appropriate policy response would encourage investment to spread itself around, and encourage workers to move and/or seek retraining.

Trade deficits highlight domestic problems that need addressing

Most importantly of all, a trade deficit can point to imbalances elsewhere in the economy.  A capital account surplus suggests that the economy is producing profitable investment opportunities that exceed what the available pool of domestic savings can finance.  

In our case, domestic savings are inadequate mainly because of government budget deficits.  Less government borrowing would leave more savings in the domestic pool, which would reduce the capital account surplus, which would in turn reduce the trade deficit.  

A trade deficit that is driven by a budget deficit, as ours is, is in fact a serious problem. The solution lies not in policies designed to limit imports, but rather in a focused effort to reduce government borrowing.

Beware of the wrong cure

We can think about a trade deficit like a fever.  It is generally better not to medicate the fever, but rather to seek the underlying cause.  You might reduce the discomfort of a viral fever with some aspirin, but an infection requires antibiotics.  But using the wrong medicine for the fever can make things worse.

 

 


Author

Matthew Rooney
Matthew Rooney

Matt Rooney joined the Bush Center in June 2015 from a career as a Foreign Service Officer with the U.S. Department of State.  At postings in Washington and abroad, Matt focused on advocating market-driven solutions to economic policy challenges in both industrialized and developing countries, and on protecting the interests of U.S. companies abroad. 

In Washington, Matt was on loan to the U.S. Chamber of Commerce to create a high-level private sector advisory body for the Summits of the Americas, working closely with the U.S. private sector and with companies and business associations from throughout the Americas to negotiate an agenda to promote economic integration in the region for presentation to the leaders of the Americas.  Previously, he was Deputy Assistant Secretary responsible for relations with Canada and Mexico and for regional economic policy.   Prior to this, as Director of the Office of Economic Policy, he led interagency and international negotiations in 2008 that produced the Secretary’s Pathways to Prosperity in the Americas initiative, designed to engage with our Free Trade Agreement partners on strategies for ensuring that the benefits of globalization are broadly shared in our societies.

Abroad, Matt was Consul General in Munich, a Consulate General providing a full range of Consular and export promotion services, supporting a permanent presence of 30,000 U.S. forces in two major base complexes, and performing political and economic analysis in support of U.S. diplomatic objectives in Germany. As Counselor for Economic and Commercial Affairs at the U.S. Embassy in San Salvador, El Salvador, he laid the groundwork for free trade negotiations between the United States and the five countries of Central America, and promoted market-based reforms for electrical power.  Prior to this, Matt served in various posts in Germany, Gabon and Côte d’Ivoire. 

Matt studied Economics, German and French at the University of Texas at Austin and received his Master’s Degree in International Management at the University of Texas at Dallas.  With his wife Dianna, Matt has two young adult sons.

Full Bio

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