The trade deficit: An imagined problem

Here’s the thing about international trade: If it weren’t mutually beneficial, it wouldn’t happen!

Whether we’re talking about purchases by consumers or businesses – domestic or international -- every market transaction involves a buyer and a seller. Generally, sellers post their prices and buyers survey the population of suppliers looking for the best deal – a determination that likely involves consideration of both price and quality.

Economists talk about “revealed preference,” which is a concept that applies here. Simply stated, when a transaction takes place between two parties operating in their respective self-interests, we can conclude that both parties see the transaction as improving their well-being. Making the trade reflects the idea that the deal is the best alternative available to the parties.

Given that understanding, how can anyone hold to the view that the US is being screwed by our trading partners? That makes no sense. Trump’s assertion that the US is being systematically ripped off is absurd. Let’s be clear: When US residents buy products from France, they’re not screwing Germany; and when Japanese residents buy from England, they’re not screwing the US. This is the way capitalism works, and it allows contractual arrangements to foster the greatest efficiencies.

An oft heard complaint is that our competitors are achieving a competitive advantage relative to us by unfairly subsidizing their home-based industries. I’m sure that happens, but it happens here, as well. Our farm sector and our energy sector, which together comprise about 50 percent of US exports, are sectors that are heavily subsidized. I don’t think we’re quite in the position to be calling out other countries for taking similar actions.

To put the issue in perspective, the last time the US ran a trade surplus (i.e., exports exceeding imports) was 1975; and while we’ve had deficits since then, over the last 15 years or so, the percentage of the trade deficit relative to GDP hasn’t shown any significant rise. As the accompanying chart demonstrates, the most recent percentage remains well below the historical high of about 14 percent posted during George W. Bush’s presidency. Currently, the trade deficit stands at about 8 percent of the US GDP, which is in line with the percentages that persisted through the halcyon ten years prior to the COVID pandemic.

It’s also important to appreciate the difference between the balance of trade and the balance of payments. The first measures the difference between imports of goods and services and exports. The balance of payments, on the other hand, captures all international cash flows. That is, besides accounting for cashflows pertaining to imports and export, the balance of payments also counts cashflows relating to investments, including transactions for securities and corporate and government debt.

While countries may run trade deficits or surpluses, the balance of payments is always in balance. That means that outflows of dollars associated with a trade deficit return to the US in the form of investments made by foreigners into the US; and importantly, those investments include the purchase of US government debt. The willingness of foreigners to hold US debt is at least partially responsible for our interest rates being lower than they otherwise would be, in the absence of these purchasers. What’s so bad about that? Because we import more than we export, we end up with greater foreign investment into our country than investments we make to projects in other countries. Doesn’t sound so terrible to me.

That Trump seems not to understand these basic foundational elements of international finance may not be all that surprising, but the fact that none of his advisors seem willing or able counter his ignorance is truly horrifying.