Home » Money » Trade Deficits – Bad?

Trade Deficits – Bad?

The nearly permanent US trade deficit is getting a lot of attention. Surely, it’s a bad thing to send so much money outside the US when it could be providing jobs to American workers, yes? The problem largely goes without saying, and is never actually discussed.

But are trade deficits really that bad? As with most things in economics, the short answer is no but the long answer is yes. Let’s discuss.

Where are all those containers going?

A trade deficit is simply a measure of how much money is flowing in and out of any given geographical area on a cash flow basis. It has to include goods and services both, an important distinction which is usually overlooked. But even with this added to it, trade deficits do not include capital flows, or money for investment, which is completely separate. It is simply the ongoing cash flow of consumables in one form or another.

It appears bad to have wealth leaking out of a nation for many reasons, but a trade deficit is a very imperfect measure of it. For one thing, money itself is not a measure of wealth given that the different purchasing power currencies varies widely. This is why a permanent US trade deficit is at least in part a feature of the US Dollar performing as the global reserve currency, or main measure of trade. Dollars are more valuable than they would be if they only measured the US market rather than the entire planet.

Aside from that, trade deficits really do only measure consumables or the turnover in the economy. Savings rates vary dramatically from one nation to the other, which is a large part of what’s being measured.

Locked together. Note all the arms are rather pale.

In a perfectly balanced world, goods and services purchased from one nation would be offset by purchases from their trading partner. But we know that in some nations the savings rate is much higher, meaning that they simply don’t buy as much. It’s not that they are buying their own goods as it is that they are buying nothing.

The global average savings rate, or the amount of the national product that is not spent, is about 25%. In the US it is 18%, a bit low. In the developing world, particularly in Asia, it tends to run much higher. China, for example, has one of the highest savings rates in the world at 47%. They simply aren’t buying anything, let alone American goods, for the money they take in from trade.

While some of that money does indeed going into cash in a mattress, much of it makes its way to global capital markets. The main reason why so much money comes in from China, distorting our cost of capital, is that they have it. They could instead spend their money on goods, but they don’t for many reasons. Chief among these are demographics, the curse of an aging population – which always drives up savings rates.

Time to polish up this … brand.

There are, of course, issues with the availability of foreign goods for consumers in developing markets, particularly China. But these are dwarfed by social issues that include a newly wealthy population that is very much used to doing without and the Confucian value of saving, especially for retirement. It’s worth noting that China does not have a system like Social Security that provides pensions for everyone, meaning that a high savings rate is absolutely essential.

The effect of savings as a driving force in trade imbalances can indeed be measured, if imperfectly. We can ask whether capital is cheaper than it has been historically and use that result to measure how much of the trade deficit is caused by savings, or capital creation. The historically low interest rates, remarkably close to zero, are a reflection of this all around the world. As we exit the previous depression people are simply not spending very much money all around the world for various reasons.

So is a trade deficit a bad thing? In the long term, a nation leaking out wealth is a problem. Then again, we can reasonably expect this as the planet evens out through open trade and development. It does mean that goods are made overseas, but it also means that consumers are getting cheaper goods.

It is a problem in the very long term, as it points to imbalances in the global system. Then again, we know that some of them are present and many will simply work themselves out. It is a cause for attention, but not in the short term.

While there is a need for careful policy that balances currencies and savings rates, there is no need for drastic, blunt-force action like tariffs. They won’t work anyway. The systemic imbalances are a concern, but they have to be dealt with systemically. The current trade imbalance is more of a measure of shifting standards of wealth and demographic concerns that should be addressed as the long-term issues they really are.

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3 thoughts on “Trade Deficits – Bad?

  1. Which raises the question what is the real problem? If it is really all about money issues then there has to be a way to fix it without taxing the consumer which is all a tarrif is.

  2. Pingback: The Disconnect | Barataria - The work of Erik Hare

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