The Myth of the U.S. Trade Deficit

Joseph P. Quinlan, Senior Global Economist at Morgan Stanley Dean Witter and noted author had this to say regarding the unhealthy obsession over the growing U.S Trade Deficit in 2001:

“The United States is obsessed with its ever-growing trade deficit. Yet trade is no longer a valid measure of global competitiveness. Today U.S. firms compete in the world marketplace through foreign-affiliate sales instead of exports – and they do so with unparalleled success. Overblown fears about the burgeoning trade deficit, along with a slowing U.S. economy, could spark protectionist policies in Washington, which could then trigger retaliations around the globe. This outcome – not the size of the trade deficit – is the greatest danger.”

This statement completely summarizes my true feelings about this topic. Nothing I could have written could so succinctly state my point of view. But in order to get a clearer picture of what Mr. Quinlan speaks about, we have to back up and answer a few simple questions.


What EXACTLY is the U.S. Trade Deficit?

Basically, the simplest explanation of the U.S Trade Deficit (USTD) is a perceived imbalance of trade and investment that includes the following four points:

  • The US is importing more products into the country than it is exporting products to sell OUTSIDE the country.
  • The US is spending more money on foreign direct investment (investment outside the US) than other countries are spending on foreign direct investment here in the US.
  • US firms are uncompetitive, unfairly treated, and/or unfairly regulated on foreign soil.
  • US residents spend much more than they save, which can cause problems.

The U.S. trade deficit is the result of a net inflow of capital to the United States from the rest of the world. Because of our stable and relatively free domestic market, we remain the world’s most popular destination for foreign investment. We have become a net importer of capital because Americans do not save enough to finance all the available investment opportunities in our economy. This inflow of capital from abroad allows us to pay for imports over and above what we export.
In other words, the trade deficit is simply a mirror reflection of the larger macroeconomic reality that investment in the United States exceeds domestic savings. If we want to change the U.S. trade deficit we must change the rate at which Americans save and invest.

America’s widening trade and current account deficits give the impression that the country is headed for trouble. Just ask Alan Greenspan, he is one of the most vocal opponents of world trade. Greenspan, the US Federal Reserve chief has warned that the deficit in US trade with the rest of the world cannot be sustained indefinitely. But Mr. Greenspan, in a speech in Germany, could not say when or how an adjustment to correct this situation, would take place.
In Spanish, we have a saying:

“El leon no es como lo pintan”

Loosely translated, this means “The lion really doesn’t look much like its portrait”. In other words, appearances can be deceiving, and nothing could be further from the truth!


Now that we have an idea of what the trade deficit is, we can ask ourselves, “Does this really affect the country?” The answer may surprise you – it doesn’t!

Why doesn’t this affect us? Well, we must first understand that exports are not the major indicator of US economic success. Simply put, American firms compete more through foreign direct investment – they establish a local presence in international markets by operating on the ground – than through arm’s-length trade.

Lost amid the newspaper headlines of a record trade deficit in April 2004 ($48.3 billion) and a record current account deficit in the first quarter of 2004 ($144 billion) is this: global business and global earnings have never been better for U.S. multinationals. A more robust global economy – in conjunction with continued U.S. dollar weakness – has sparked a boom in global profits.

In 2001, for instance, the last year of available data, U.S. foreign affiliate sales topped nearly $3 trillion – roughly three times larger than U.S. exports of goods and services. Because foreign affiliate sales are not included in U.S. exports, a great deal of global commerce is missing from the reported trade figures.


So, the global economy is bad for US companies right? Don’t tell that to Federal Express, which – helped by soaring international sales – posted stronger-than-expected quarterly results. One of the most dangerous deficits today is not one of trade but rather a deficit in understanding how U.S. firms compete and sell products in the world marketplace.
A trade deficit that reflects both rising exports and even more rapidly rising imports can be a sign of health. That has been the case in the United States for most of past two decades. Since 1980, the U.S economy has grown an average of 3.1 percent in years in which the current account deficit has expanded from the previous year, and an average of only 2.0 percent in years in which the deficit has shrunk. If trade deficits are bad for growth, why does the U.S. economy grow more than 50 percent faster when the trade deficit expands?

Frankly, we would have more reason to worry if the U.S. were running a trade surplus. In Mexico in 1995 and more recently in South Korea and other East Asian countries, trade balances flipped overnight from deficit to surplus because of plunging domestic demand and the flight of foreign capital. In Japan today, a soaring trade surplus has been accompanied by record high unemployment. It’s no coincidence that America’s smallest trade deficit in recent years occurred in 1991 – in the middle of our last recession.

What does all this mean for us? First, there is no emergency. The trade deficit is not a sign of economic distress, but of rising domestic demand and investment. Second, the trade deficit is largely immune to changes in trade policy. Imposing new trade barriers will only make Americans worse off while leaving the trade deficit virtually unchanged.
In other words, appearances can be deceiving, and nothing could be further from the truth!

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