The Trade Deficit Boogey Man

At the risk of being called a “dupe,” or insinuated as being one, or at minimum, someone who is easily duped by reading just one article, I will espouse some views on the trade deficit topic.

Earlier, I linked to an article by Neal Asbury entitled TRADE VISION DEFICIT DISORDER. While I agreed with the many points in Asbury's column, I did not agree with everything. My overall take on the article was on how to increase our exporting, thus enhancing our global trading position, which should spur U.S. production of goods and create more jobs here at home.

I think Mr. Asbury outlined a number of reasons why we are not as competitive as we can be, and highlighted many things that we can do to enhance our trading positions. And, even though his column title mentioned "trade deficit," the thrust of his article was on how to improve (increase) our export trade.

I am interested in increasing production, creating jobs, and increasing exports. I do not get hung up on the idea of trade deficit per se. After all, those who get hysterical over international trade, would make you think that the whole purpose of international trade is to export as much of what we have produced as possible, while importing as little as possible of what other countries have produced. What better way to improve our "trade deficit" or turn it into a positive trade situation?

But what is the point of that? Lest you be confused, having a trade deficit does not mean we are in debt to foreigners.

Look at it this way: You buy groceries every week from your favorite grocer. You probably spend a few thousand dollars a year there. But how much does the grocery store buy from you? Nothing. Is it a problem?

No.

In fact, it only would be a problem if you tried to balance your "trade deficit," with the grocery store by buying from them only to the extent that it needed your services. You most likely would starve. You would be engaged in a bartering system; a system that mankind found extremely unsuitable many moons ago and ditched it for a money economy.

"Trade statistics obscure reality. Individuals exchange only when each expects to benefit. If they didn't expect it, they wouldn't trade. That's true even if one party is American and the other Chinese. Trade is trade.

Foreigners trade cool products (and capital goods) for paper money. They can do only three things with our dollars: buy American goods and services, save them, or invest in the United States (including buying U.S. government debt).

In other words, most of what foreigners don't spend here, they invest here. The trade deficit is mirrored by the capital-account surplus." ¹

Of course, the U.S. runs not only a trade deficit with China; it runs a trade deficit with the whole world. But this fact isn’t worrisome.

Why do foreigners willingly ship more goods and services to the United States than they demand in return? The answer is that foreigners find America to be an astonishingly attractive place to invest. To invest in the U.S., however, requires dollars. Foreigners get these dollars for investment by buying fewer goods and services from Americans than Americans buy from them. That is, foreigners save and then invest a large bulk of their savings here.

This investment creates jobs, improves worker productivity, and increases American economic output just as investment made by Americans. It’s a blessing; it’s a benefit; it’s a ringing testament to the dynamism and strength of the U.S. economy. 2

Millions of Americans get jobs because of international trade. And we, as consumers, do benefit from getting what we want, whenever we want, from wherever we want, at the lowest price, or of the highest quality.

Yet, the only way to shrink the trade deficit is for the government to prohibit us from buying whatever we want, from whomever we want. This can be accomplished by tariffs. This leads to increased isolationism.

If we want to "level the playing field" in international trade, we can either put tariffs in place on imported goods, or strike "free trade" agreements with individual countries so that we are on equal footing in our business dealings with them, i.e no restrictions on either party.

Still, all we seem to hear in the media is that our trade deficit keeps going up and the free trade agreements are bad. So again I ask, is a "trade deficit" bad?

The answer is still, "No."

Historically, countries with trade surpluses often don't do very well. Japan had a trade surplus all during its long recession, which began in 1990 and is only now ending. By contrast, countries running trade deficits often experience economic booms. A Cato Institute study shows, "Contrary to prevailing assumptions, 'worsening' trade deficits are associated with faster GDP and manufacturing growth and more rapidly declining unemployment, while 'improving' trade deficits are associated with slower GDP and manufacturing growth and rising unemployment."

Historically, we have been in a trade deficit position. However, during our depression era, we were in a trade surplus situation. In fact, in nine out of the 10 years of the Great Depression were in a positive trade position. Our economy should have been booming. Once again showing that a trade surplus position is not some magic elixir to cure a sick economy. Economies are far too complex to draw simplistic causal connections between trade deficits and surpluses and economic welfare and growth.

"Economic theory and experience show that trade deficits are driven by levels of national saving and investment in the U.S. economy, not by allegedly unfair trade barriers abroad or by declining industrial competitiveness at home. America's record trade deficit is a symbol of economic strength, reflecting a strong net inflow of foreign investment drawn to America's dynamic economy.

Growing trade deficits signal improving economic conditions, while shrinking deficits often occur in times of economic trouble. During the last 25 years, the U.S. economy has on average grown about a percentage point faster, 3.5 percent vs. 2.6 percent, in years when the trade deficit expanded compared with years when it shrank. The unemployment rate on average fell 0.4 percentage points during years of rising deficits and rose 0.4 points when the deficit shrank. Manufacturing output rose much faster during years of rising trade deficits than during years of shrinking deficits.

America's largest trade deficits in recent decades occurred during economic expansions, its smallest deficits during recessions. It's no coincidence that as the economy shows signs of slowing down, the monthly trade deficit numbers have also begun to shrink with the economy's growth rate. (Those critics who demand that something be done to "fix" the trade deficit should be concerned that they might get what they ask for.)

The best policy is to ignore the trade deficit, however large it may now seem, and concentrate on maintaining a strong and open domestic economy that welcomes foreign investment. As long as investors world-wide see the United States as a safe and profitable haven for their savings, the trade deficit will persist, and Americans will be better off because of it."³