It has reached an all-time record high, and it’s growing rapidly in each of Trump’s years in office, even though it had completely stabilized in the previous six years.
The trade deficit in goods held steady in the 2011-2016 period, rarely varying much from about $730 billion. In fact it actually declined insignificantly in that period, from $736 billion in 2011 to $730 billion in 2016. But it has shot up in the Trump era, increasing by about 8% in 2017, then more than 10% in 2018.
That’s true, but it doesn’t mean we’re miserable failures.
Despite what our Chief Executive thinks, the trade deficit is not an economic scorecard which is directly correlated to success or failure. As our contributor Adam keeps reminding us, economics is a complicated field. The trade deficit is a complex equation involving currency strength, relative prosperity, economic growth rates, and a bunch of other factors that are way too abstruse for me, but I’m sure Adam will edify us about any place where I have left gaps.
Some trade deficits can be bad, others are not at all.
Let’s say a rich but very cold country called McDuckburg really needs warm wool clothing, but has few sheep and a highly educated populace with with few people willing to work in sheep raising unless they get the comfortable wage package necessary to live adequately in McDuckburg, with its high cost of living. This situation, high demand + low supply + high producer costs, causes home-produced wool clothing to be tremendously expensive. Meanwhile, a poor country named Beggarland, given its temperate climate, is filled with sheep, and has a work force that is thrilled with a low wage to raise sheep and make clothing from them. Moreover, and that relatively low wage gives them a decent standard of living in Beggarland. The people of Beggarland can’t afford to buy any of the computers and luxury autos produced by McDuckburg. Therefore, there is a massive trade deficit, as McDuckburg only buys and Beggarland only sells.
Now does that mean McDuckburg loses on the deal? Of course not. Its people get something they need, and they get it at a very low price. That also frees up buying power which gets poured into other sectors of the economy. That trade imbalance is good for both countries. It would be foolish and inefficient for McDuckburg to try to cultivate a domestic wool market, especially if their government had to subsidize sheep farmers.
Now that all seems obvious when I label it with imaginary names, but people will actually argue against it if I substitute real country names and and talk about real products. Nearly half of the trade deficit of The United States is with China, but there’s a logical reason for that, and it’s quite similar to the theoretical Beggarland example. They can produce things we want, and can do so far cheaper than we can.
There are also other logical reasons why the trade gap is suddenly widening after years of stability, with China and elsewhere, despite the President’s protective tariffs.
(1) His tariffs inspire counter-tariffs, thereby reducing American exports;
(2) China’s economy is sluggish, thus reducing their ability to buy American goods, and further reducing American exports. Exports to China actually declined in 2018, while imports increased, despite the tariffs.
(3) We just had a big tax cut in America, and tax cuts increase demand for goods, including foreign goods, thus increasing American imports.
(4) The dollar is very strong, thus making it cheaper for American consumers to buy imports, and more difficult for foreign customers to buy our exports.
(5) Some American companies have been rushing to stockpile imported goods before Trump imposes tariffs.
Again, it’s complicated, and in some ways the burgeoning trade deficit with China is a sign that the US economy and the dollar are strong while the Chinese economy and the yen are not.
But President Trump is not a complex thinker. He thinks trade deficits are automatically bad, so it will be interesting to see how he’ll react to this news. Obviously, he will not admit that he is directly responsible for something he considers bad, so he has only two other options:
(1) Reverse his position, say the trade deficits are actually a good indication, reflecting a strong dollar and the powerful economy he has built, although some things may still need tinkering, and maybe he could ease or completely re-evaluate his tariffs;
OR
(2) continue to believe deficits are evil, and find somebody or something else to scapegoat, while doubling down on his foolish tariff strategy.
Now the first option is totally positive, would cause the stock market to respond positively, and even gives him a chance to crow about his successes. The second is not only negative and petty, but woefully ignorant.
Negative? Petty? Ignorant? That was probably the motto on his business card. My money is on #2.
That’s right, son.
I read Othercrap for the articles.
Twin deficit hypothesis. Been around for years. TCJA made the 2018 trade deficits pretty predictable.
Finally, finally: you wrote: The trade deficit is a complex equation involving currency strength, relative prosperity, economic growth rates, and a bunch of other factors that are way too abstruse for me,
I haven’t mentioned any of those things, I find them to be ‘red herrings’ that confuse following the effects (in this case, literally following the money of imports minus exports and net flows of investments.)
The only thing that has any importance is there is an effect on imports and exports via changes in a currency’s value. When a nation imports more than it exports, it is selling more of its currency than its buying. While that money HAS TO come back, it does not trade when it comes back. So, this causes the currency to decline in value, all else remaining equal. Of course, that makes imports more expensive and that nations exports less expensive. So, this leads to a self correcting mechanism.
However, because the U.S is the ‘world’s reserve currency’, this causes businesses buying resources traded in U.S dollars to have to buy U.S dollars. This extra buying of U.S dollars causes the U.S dollar to trade higher than it otherwise would. As far as I can tell, while the U.S had this increase in a trade deficit, the U.S dollar has actually gone up in value relative to most other world currencies.
Of course, there are other effects of an increasing trade deficit, like the potential loss of jobs as Americans may have shifted from buying goods or services made in the U.S to those made abroad. But, in a U.S GDP of $20.5 trillion, the effect of a $90 billion increase in the trade deficit in a given year is likely to be relatively negligible (of course, those who may have lost their jobs over this tend not to think so.)
Sorry, I dropped off a line: In order for McDuckburg to buy Beggarland’s goods and services, it has to sell its currency and buy Beggerland’s currency. So, let’s assume the only two countries are Beggerland and McDuckburg. The only people who can buy McDuckburg’s currency are Beggerlanders. (And it continues:) Now, can a person in Beggerland they go to the store and buy something with currency from McDuckburg. If you go to an American store and try to buy something with Chinese Yuan, what is most likely to happen?
When the United States first started to run up large trade (current account) deficits in the 1980s, you may recall that at that time the United States was buying a lot of goods from Japan and the Japanese people (and governments) were buying up all sorts of buildings in America. This is because the Japanese people had to invest those U.S dollars somewhere, so, at least according to the popular press, all the Japanese bought buildings in the United States.
Now, the United States is a little different for two reasons:
1.Some people outside the U.S (and nations) use the U.S dollars for their own currencies. Of course, when people outside the U.S use the U.S dollar, this is part of their black market. Some nations that have had major inflation problems have adopted the U.S currency in order to provide financial discipline and stability.
2.The United States is the ‘World Reserve Currency’ which means, for instance, that the Chinese government and businesses, rather than investing U.S dollars back in the U.S can buy oil and other resources that are traded in U.S dollars.
The difference between the Current Account and the Capital Account is called the ‘official settlement account.’ I have no idea what this amount is. However, it does mean that if the U.S has a Current Account deficit is greater than its Capital Account surplus, the U.S has to sell reserves of currency (or even gold.)
However, this is where marginal thinking comes in. If the United States has a $200 billion greater Current Account deficit than a Capital Account surplus, what matters in a given year is the change in the amounts for that year.
For instance, if in 2018, the U.S with the $891 billion trade (Current Account) deficit, but also had an $891 billion Capital Account (Investment) Surplus, then the net for 2018 is zero.
Of course, there are also people who simply trade foreign exchange and, I guess, that money might be traded around forever, but again, the only thing that matters is the increase or decrease in the amount of money traded. (The total amount, in this case, of money trading is known as the ‘stock’ of money, the increase or decrease is known as the ‘flow.’ A stock is a total at a given point, a flow is the increase or decrease over a period of time – just like the difference between a balance sheet and an income statement. Generally the important thing is the flow. Obviously the flow is generally going to be much smaller than the stock.)
So, is the trade deficit a bad thing? Well, Trump clearly genuinely believes that the $891 billion are dollars that go out of the United States and never return. But, he’s simply wrong: the money returns as investments in the United States economy.
So, is that a bad thing? If you thought it was bad when the Japanese were buying up buildings in the U.S, I guess it is a bad thing to you. A foreign company or individual buying a building or opening a business with the, in this case, U.S dollars received is said to be making a ‘foreign direct investment.’ As much as when foreigners buy buildings in the U.S, a lot of Americans tend not to like it, however, when a foreign business opens up a plant or an operation in the United States, Americans tend to like it.
Since,as in the example you gave, a nation can not sell its assets forever in order to import, I suppose there may be a problem with persistent and large current account (trade) deficits. However, as long as foreigners invest in new things (new plants as opposed to existing businesses) new stocks being issued (foreign purchases of stocks and other assets like that are referred to as ‘foreign indirect investment’) I don’t see a problem with having a current account deficit and a capital account surplus.
Finally, the current account and the capital account together are known as the ‘balance of payments.’
From Investopedia: According to Nobel laureate Milton Friedman, trade deficits are not ever harmful in the long run because the currency will always come back to the country in some form or another, such as via foreign investment.
Just to make a few things more precise:
This is because the Japanese people had to invest those U.S dollars somewhere, should say: had to invest those U.S dollars in something in the United States.
Some people outside the U.S (and nations) should say: ‘(and some small nations.’)
I have no idea what this amount is. Should say: I have no idea what this amount is for the United States.
These effects aren’t necessarily ‘follow the money’ (as an aside, Mark Felt AKA Deep Throat is never quoted saying that in the book All the President’s Men, it was a line written for the movie) but ‘follow the process.’
In this case: “Therefore, there is a massive trade deficit, as McDuckburg only buys and Beggarland only sells.” So, after this first order effect what happens next? Well, what is the process?
In order for McDuckburg to buy Beggarland’s goods and services, it has to sell its currency and buy Beggerland’s currency. So, let’s assume the only two countries are Beggerland and McDuckburg. Now, can a person in Beggerland they go to the store and buy something with currency from McDuckburg. If you go to an American store and try to buy something with Chinese Yuan, what is most likely to happen?
So, the people who buy the McDuckburg currency HAVE TO invest that currency in McDuckburg. Of course they don’t ‘legally’ have to, but Beggerlanders can’t spend this foreign currency in their own country. You have mentioned that McDuckburg has a current account deficit, so, this current account deficit HAS TO be offset by an equal (more or less) surplus called the Capital Account.
Of course, in your example if Beggerlanders only sell and McDuckburgs only buy, McDuckburg is going to run out of assets for Beggerlanders to buy pretty quickly, but obviously this is a completely fictional example.
1.McDuckburg and Beggerland are an example of ‘comparative advantage’ first theorized by British economist David Ricardo.
Economics really isn’t all that difficult. Like the sciences, it’s comprised of two things: a body of facts and a method of thinking. I suppose part of why people might think economics is complex is because, unlike science where the body of facts are based on repeatability, economics is conditional. For instance, Is the economy operating at full potential output or is it in a recession? What happens next depends on that condition.
However, there are really two interrelated concepts to ‘thinking economically.’ The first is following first order effects/second order effects and so on. The second is a joke I’m sure some economist has told: how does an economist think: marginally.
First order effects/second order effects are, I guess, no different than thinking however many moves ahead in chess. However, by the sixth order or so, it’s more like 3D chess.