BOHANON & STYRING: Trade deficit not as black and white as it seems

Recent reports indicate that the U.S. trade deficit was $500 billion in 2015. Sounds ominous and cataclysmic, but a look behind the number is revealing. The full report from the Commerce Department shows that, in 2015, the United States exported $2.261 trillion of goods and services while it imported $2.761 trillion, for a deficit of $500 billion. This summary of trade in goods and services is the main component of what economists call the “current account.”

What the current account does not indicate is what foreigners did with the excess $500 billion they earned in the U.S. economy. We know they did not use it to buy U.S. goods and services in 2015 because, if they did, it would count as U.S. exports and the $500 billion deficit would be incorrect. So foreigners must have either held the dollars as cash or bought dollar-denominated financial assets such as a U.S. government bond. In any case, they have acquired $500 billion in U.S. assets.

Just as the United States and the rest of the world trade goods and services, they also trade financial and real assets. In 2015, Americans bought foreign assets and foreigners bought U.S. assets. This is reported in the “capital account” that is reported sporadically and with little fanfare in the press. As a first approximation, we know foreigners bought $500 billion more of U.S. assets than Americans bought of theirs. We know the United States ran a capital account surplus of $500 billion in 2015. Why? Because where else did the $500 billion surplus the foreigners earned in the current account go? A fundamental principle of international economics is the accounting proposition that a current account imbalance is offset by an equal but opposite imbalance in the capital account. It’s not theory; it’s arithmetic.

We say as first approximation because other items such as dividends interest payments and unilateral transfers are also in the current account. Nevertheless, the point is taken: The scary-sounding half-a-trillion-dollar deficit in goods and services implies by definition a rosy-sounding half-a-trillion surplus of net investment in the U.S. economy.

So is this good or bad? It all depends. A nation that attracts a lot of outside investment that builds its economy will run a trade deficit. A nation that is issuing a lot of wasteful government debt will also run a trade deficit. We will leave it to the reader to decide which characterizes the United States.•

__________

Bohanon is a professor of economics at Ball State University. Styring is an economist and independent researcher. Both also blog at INforefront.com. Send comments to ibjedit@ibj.com.