What really causes America’s chronic deficit in international trade

A fundamental error that seems to motivate the Trump administration’s policy on international trade was starkly articulated on Firing Line recently by Peter Navarro, the President’s assistant for trade and manufacturing policy. The Firing Line host Margaret Hoover asked Navarro to explain the Trump administration’s actions against trade with Germany. He responded: “If you look at our trade deficit with Europe, it’s $150 billion, right? Just rough rule of thumb is $1 billion of trade deficit is 6,000 jobs you ship offshore, okay? So it’s a big number. And the only reason why we have that deficit is because of a whole range of unfair trade practices that Europe engages in.”

One may question Navarro’s assertion about how a trade deficit affects employment, but let us focus here on his expressed assumption that America’s trade deficit with other countries is caused by their unfair trade practices against American exports. This sounds so logical that few people bother to question it, but it is wrong.

America’s trade deficit is the difference between the total value of the goods and services that Americans buy from other countries (our imports) and the total value of the goods and services that Americans sell to other countries (our exports). These are big aggregates, and they are affected by many factors. But the primary factor that ultimately drives America’s total trade deficit is the desire of foreigners to invest in America.

When Americans buy goods and services from foreigners, we pay them in US dollars. But there is just one basic reason for anybody to want US dollars: because they can be used to buy things in America. US dollars can be used to buy goods and services in America, or they can be used to buy investments in America. Foreign purchases of American goods and services are counted as exports in America’s trade balance, but foreign purchases of American stocks and bonds are not, and that is the key to understanding what causes imbalances in international trade.

If foreigners had no desire to invest in America, then they would use all the dollars that they got from us to purchase American goods and services, which would be counted as exports in America’s international-trade accounts. Even if foreign governments “unfairly” imposed taxes and quotas on American exports, foreigners would still want to use their American money as well as possible to buy things from America. Foreigners who do not want to invest in America would certainly have no motivation to simply hoard the dollars that we paid them for our imports.*

So in a world where foreigners did not want to acquire investments in America, America’s international trade in goods and services would be generally balanced, as all the dollars that Americans spend on imports would return promptly in demand for American exports. In this world, unfair trade barriers could reduce the volume of trade and could affect the exchange rate between the US dollar and other currencies, and trade barriers could affect the distribution of deficits and surpluses in America’s bilateral trade relationships with individual countries; but trade barriers could not affect the overall balance between the total global values of America’s exports and imports.

If we really want to understand America’s deficit in the international trade of goods and services, we must recognize that this trade deficit is just equal to the net investment that is flowing from the rest of the world into America. When foreigners want to invest their savings in safe bonds from the US government or in securities from well-managed US corporations, the dollars that are needed to buy such investments can only come from the excess of the dollars that Americans send abroad, in payment for US imports, over the dollars that foreigners send back to pay for US exports.

In effect, investments in American stocks and bonds and other assets may be viewed as America’s “stealth exports” that balance the international trade accounts. If foreigners want to acquire these investments from America then they must sell more goods and services to America, and that is the force that drives the trade deficit. When we count the jobs that are lost or gained because of international trade, we should remember to include the gain of jobs from corporate and government spending that are funded from global investments in American stocks and bonds. We may doubt that Peter Navarro was considering these jobs in his estimate of the effects of a trade deficit on employment, even though a substantial portion of the $150 billion deficit with Europe has surely been invested in US Treasury bills which helped to fund Mr Navarro’s own salary.

Among the investments that America is selling to the world, none are more important than the debt of the US federal government. The US Treasury sells its bills, notes, and bonds to investors all over the world. So it may be appropriate to look for a link between the two famous deficits, the US government’s fiscal deficit and America’s international-trade deficit. These two deficits fluctuate differently from year to year, but both have averaged around $500 billion per year since 2000. Thus, in recent decades, America’s trade deficit has effectively brought in enough foreign savings to finance the fiscal deficit of the US federal government. Of course, much US federal debt is still held by Americans, and foreigners have also purchased other assets in America. But we should understand that America’s trade deficit has been driven more by global demand for US federal debt than by any unfair foreign trade practices.

If there is something to worry about in this picture, it is the increasing debt of the US government, which will be a real burden on American taxpayers in coming generations. Trade barriers in any country can harm its domestic consumers and its foreign suppliers, but trade barriers are not the root cause of America’s chronic overall trade deficit. As long as America is generally considered the safest and most reliable country in the world, global economic growth will cause a chronic deficit in America’s international trade, so that people throughout the world can get the dollars that they need to acquire the investments that they want in America.


*Note: Dollars are issued by the US Federal Reserve as a form of US government debt that does not pay interest, and so a hoard of US dollars can also be considered an investment in America.


4 Responses to “What really causes America’s chronic deficit in international trade”

  1. Russel Murphy Says:

    Granted, US Government debt is something to worry about, especially as it seems that the current administration is not investing in goods (especially infrastructure) or services (such as a national healthcare programme) that would benefit the economy as a whole and would actually contribute to an increase in government revenues. But do not also ignore the increasing debt of Wall Street, which should be at least as worrying as US Government debt.

  2. H Cunha Says:

    From an American viewpoint, probably the most important aspect of this whole thing is that the smartest and most capable foreign entrepreneurs and investors choose to apply or invest some significant portion of their dollar assets in the U.S. This helps keep the US economy very competitive.

    Nevertheless, US investors investing abroad still buy more equity stakes in foreign firms than foreigners buy in US firms. Foreign FDI buys more US corporate bonds than US investors buy abroad. Hence returns to US investors abroad has been better than returns to foreign investors in the US. That’s the current trend.

    Overall, on the public side, the foreign reserves of the central banks of about 20 nations is roughly equal to the entire American public debt. They need these reserves in order to ensure the stability of financial flows. Lending these dollars back to the US Treasury ensures they earn something on these dollars.

    It probably could be argued that if the US taxed more (creating savings), it could reduce its trade deficit, and its public debt. But you’d have to model that with changes in interest rates, exchange rates, public and private investment, and inflation. I have no idea what the optima might be in terms of growth.

    To what extent the US economy does best in terms of a lesser or greater exposure to the world is a good question.

  3. George H. Blackford Says:

    Re: “When we count the jobs that are lost or gained because of international trade, we should remember to include the gain of jobs from corporate and government spending that are funded from global investments in American stocks and bonds….

    “Among the investments that America is selling to the world, none are more important than the debt of the US federal government….”

    This is bizarre. It fails to make a distinction between real and financial investment. Financial investments do not create jobs! (See: http://www.rweconomics.com/htm/Pro.htm )

    According to Bureau of Economic Analysis’ statistics less than 25% of foreign investment in the United States is Direct Foreign Investment (DFI), and the bulk of DFI involves the purchase of existing real and financial assets rather than newly produced real assets. https://www.bea.gov/international/bp_web/tb_download_type_modern.cfm?list=2&RowID=144

    Selling our assets off to foreigners is not exactly the kind of thing that makes the US prosperous.

    Nor does this article acknowledge that the manipulation of international capital flows is the mechanism by which foreign countries, such as Japan and the other Asian Tigers, peg their currencies to the US dollar so as to keep their exchange rates low and our exchange rate high, and that it is this kind of manipulation that has been so devastating to the manufacturing sector of our economy over the past 40 years.

    What is truly amazing about the failure to understand this is that Hobson predicted the situation the West is in today over 100 years ago, and, yet, economists today can’t seem to figure it out:

    . “Free Trade can nowise guarantee the maintenance of industry, or of an industrial population upon any particular country, and there is no consideration, theoretic or practical, to prevent British capital from transferring itself to China…or even to prevent Chinese capital with Chinese labour from ousting British produce in neutral markets of the world. What applies to Great Britain applies equally to the other industrial nations…. It is at least conceivable that China might so turn the tables upon the Western industrial nations, and, either by adopting their capital and organisers or…by substituting her own, might flood their markets with her cheaper manufactures, and refusing their imports in exchange might take her payment in liens upon their capital, reversing the earlier process of investment until she gradually obtained financial control over her quondam patrons and civilisers….“
    John Atkinson Hobson, Imperialism, A Study, 1902.

    The problem we have with China, Japan, and the other surplus countries today is that they have been “refusing [our] imports in exchange [for her exports and has been taking] her payment in liens upon [our] capital.”

    Hobson warned the West about this over 100 years ago, and it is beyond me how economists can ignore consequences of this practice in light of the devastation it has caused.



  4. Roger Myerson Says:

    The comment misses the point of the article, which is that the trade deficit is driven by foreigners’ desire to make investments in American assets, including notes issued by the US Treasury and the US Federal Reserve.
    The article did not deny that foreign import restrictions could harm specific industries in the US. The point of the article was only that such import restrictions are not the cause of America’s aggregate trade deficit, which would not exist if foreigners were not willing to invest in larger holdings of US dollars or other claims on US capital. Even “currency manipulation” to reduce the value of a foreign currency relative to the US dollar requires a foreign government to print its own money for the purpose of buying US dollars.
    It is strange for the commenter to claim that real spending cannot be driven by financial investments. Long term projections for the US Federal budget involve a significant portion of Federal spending to be financed by the sale of US Treasury debt to investors throughout the world. So as long as taxpayers are not paying the full cost of Federal spending, people whose jobs depend directly or indirectly on US Federal expenditures will be implicitly dependent on global demand for financial investments in US Federal debt.

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