The Japanese double-screw the US, a real trick: First they take all our money with their consumer goods, then they put it back in buying all of Manhattan. Either way we lose.--Donald Trump Playboy Interview, March 1990

After my tour of Asia, all Countries dealing with us on TRADE know that the rules have changed. The United States has to be treated fairly and in a reciprocal fashion. The massive TRADE deficits must go down quickly!--@realDonaldTrump, 9:20 p.m. 13 Nov 2017 from Dallas, TX

Nothing, however, can be more absurd than this whole doctrine of the balance of trade, upon which, not only these restraints, but almost all the other regulations of commerce are founded. When two places trade with one another, this doctrine supposes that, if the balance be even, neither of them either loses or gains; but if it leans in any degree to one side, that one of them loses and the other gains in proportion to its declension from the exact equilibrium. Both suppositions are false. A trade which is forced by means of bounties and monopolies may be and commonly is disadvantageous to the country in whose favour it is meant to be established, as I shall endeavour to show hereafter. But that trade which, without force or constraint, is naturally and regularly carried on between any two places is always advantageous, though not always equally so, to both.--Adam Smith, The Wealth of Nations, Book IV, Chapter 3.


The three quotes above give two opposite views of a country’s trade deficit. According to the first two, by Donald Trump, the U.S. trade deficit is a major problem that must be fixed. According to the third quote, by 18th-century economist Adam Smith, the idea of a balance of trade is absurd. Who’s right? I won’t keep you in suspense. President Trump is wrong and Adam Smith is right. But what matters crucially is why Trump is wrong and Smith is right.

First, the U.S. merchandise trade deficit, which is what most people are referring to when they talk about the trade deficit, is somewhat offset by the positive balance on services and further offset by the difference between income received from abroad and paid abroad.

Second, even for those who worry about the trade deficit, there’s no good reason, in a world with about 200 countries, to worry about the balance with a particular country.

Third, the deficit on goods and services, plus the difference between income received from foreigners and income paid to foreigners, is necessarily equal, except for measurement error, to the surplus in the capital account.

Fourth, an almost surefire way to reduce the merchandise trade deficit is to engineer a recession.

The U.S. negative balance on the trade of goods (the merchandise trade deficit) is offset by the positive balance on services. In 2018, American residents spent $2.562 trillion on imported goods while foreigners spent $1.674 trillion on U.S. exports of goods. The resulting U.S. merchandise trade deficit was $887 billion. But that same year American residents spent $567 billion on imported services while foreigners spent $827 billion on exports of U.S. services. The result was a $260 billion trade surplus on services. Combining goods and services, we get a trade deficit of $628 billion. There’s one more adjustment: income receipts from abroad versus payments made by people in the United States, including the U.S. government, to those abroad. Taking account of those receipts and payments, along with the trade deficit, gives us what’s called the current account deficit. In 2018, that was $491 billion. To put that into perspective, it was about 2.4 percent of that year’s GDP.

Many people share Trump’s view, stated in the second quote above, that a trade deficit is a sign of economic weakness. I think there are two reasons for that. First, many people confuse a federal trade deficit with a federal budget deficit. Second, when the media report the trade deficit numbers, their language is often biased. If the trade deficit increases, the media often tell us that it got worse. If the trade deficit falls, then we are told that it has improved.

Even if you worry about the current account deficit, there is no good reason to worry about a current account deficit with a particular country. We in America buy goods and services from scores of countries around the world. People in scores of countries buy goods and services from us. There’s no reason that the dollar value of what we buy from a particular country should equal the dollar value of what people in that country bought from us. The reason it doesn’t matter can best be seen if we drill down to trade within a country. My wife and I probably spend over $2,000 a year on groceries from our local Lucky supermarket in Pacific Grove, California. But Lucky spends nothing on goods and services from us. So our current account deficit with Lucky is over $2,000. We’re not worried. The facts don’t get scarier if we plus up to all the people in the United States and all the people in another country.

Go back to the Trump quote from the Playboy interview. At the time of that interview, his big worry was Japan, not China. His first upset was that “they take all our money with their consumer goods.” Let’s cut him some slack here because he obviously didn’t mean “all our money.” What he almost certainly meant, and what was true, was that we spent more on Japanese goods than Japanese people spent on ours. But we shouldn’t cut him slack on his verb “take.” There’s no taking. Every one of those transactions between people in the United States and people in Japan was voluntary. And why did we American consumers do this? Were we crazy or, even worse, were we cheated? No. We valued the VCRs, the Toyotas, the Hondas, and the other consumer goods that we got for that money more than we valued the money. If we hadn’t, we wouldn’t have bought the goods.

What Trump missed is even more fundamental than the intricacies of balance of payments: he didn't understand gains from trade. People buy something when they want that thing more than the money they give up. That doesn’t change when the exchange is across a border instead of across a supermarket counter. So when Trump said “we lose,” he was wrong. We won.

Trump said that the Japanese “put it back in buying all of Manhattan” and that this caused us to lose again. Of course, he didn’t mean all of Manhattan and, forgetting the “lose” part for a minute, Trump was getting at something true, namely, that when the United States has a current account deficit, it must have a capital account surplus. Take the 2018 data mentioned above. Our current account deficit, as noted, was $491 billion. Its counterpart was a capital account surplus of $445 billion. Why not $491 billion? The Department of Commerce’s Bureau of Economic Analysis explains that there was a $42 billion “statistical discrepancy.” That would plus up the capital account surplus to $487 billion, which is close to, but still not the same as, $491 billion. The small difference, the Council of Economic Advisers explains in a footnote, is due to different methods of measuring the various components.

How does that capital account surplus manifest itself? In various investments that foreigners make in the United States. They buy U.S. government bonds, property in the United States-- including Manhattan--and stock in U.S. companies, and also build or buy U.S. businesses. Trump said that when the Japanese did this, we lost. But every sale of property or any other asset to people from Japan (and today, to people in China) is voluntary. So the people selling it must see themselves as better off or they wouldn’t have sold. In short, the truth is the opposite of what Trump said. if I may coin a phrase, “Either way we win.”

What about the worry that some foreigners would hold on to the dollars that we spend on their goods? We should have such luck. Our government spends less than 13 cents to print a $100 bill. If we could spend a few Benjamins on foreign goods and people who sold the goods kept the Benjamins, our government could print more. Our motto for paper money could be like the Jay Leno line in his old Doritos ad, “Crunch all you want; we’ll make more.”

Some people worry that foreigners who own plants in the United States are a threat to this country. It’s hard to see how. Are foreigners who own businesses in America worse than Americans who own businesses? That might surprise Americans who work for them. In 1988, Democratic presidential candidate Michael Dukakis gave a speech at the Moog Automotive Company, an auto parts firm near St. Louis, in which he expressed some of the same fears that Donald Trump had at the time. “Maybe the Republican ticket wants our children to work for foreign owners, pay rent to foreign owners and owe their future to foreign owners,” he said in his speech to the workers, “but that`s not the kind of future Lloyd Bentsen [his vice-presidential running mate] and I want for America.''

There was one little problem: Dukakis’s audience did work for a foreign owner. Moog Automotive was owned by a subsidiary of a company based in Turin, Italy. Embarrassing!

Moreover, if foreigners were worse owners, then competition would surface and the businesses would be sold to Americans who run them better.

A current account deficit on its own tells us little about the health of a nation’s economy. But for the United States, one thing seems clear from our experience over the last 40 years: the current account deficit tends to fall when the economy slows or goes into a recession and rises when the economy booms. So if you want to reduce the current account deficit, engineer a recession. Do you think that’s worth it? Me neither.



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