The United States imported $2.895 trillion worth of goods and services from foreign countries in 2017 and exported $2.329 trillion, causing a deficit of $566 billion, which is expected to be even higher this year. Many influential people think that is a bad thing, and President Trump has been waging a war against trade deficits since he assumed office.
It is actually an error to say that the United States trades with, say, China. Rather, specific American firms buy specific goods and services from specific firms in China for a specific amount of money. When two firms trade, regardless of country, one must assume that each side of the bargain gets at least as much value as they give. In every case, the trade is balanced. If a million firms conduct a million balanced trades, the net result is balanced trade.
The problem that most people have with that rationale is that, by spending U.S. dollars, we are sending our wealth to other countries. As the argument goes, we get stuff to consume and decay, and the trading partners get dollars, which, according to mercantilist thinking, is real wealth. Because we send money to China, they build cities and we get trinkets, but Chinese ghost cities, however wise or unwise they are, are not built by trading partners, but rather by their government through taxes on production and government borrowing.
Let’s follow the money. Company A (American) buys $1 million worth of televisions from Company C (Chinese). That money gets deposited in an international bank. At that point, the Company C has options. It can buy products from American firms, it can invest in American productive assets, i.e. direct foreign investment, or, because it cannot use dollars to buy goods and services in China, it can sell those dollars to a currency trader for Chinese money at the going exchange rate. After that sale, the currency trader now has $1 million and Company C has $1 million worth of yuan, another balanced trade, after which it can buy $1 million worth of goods and services in China. The currency dealer must now find another buyer who will use the dollars for American goods or capital.
The wealth of a nation is the sum total of wealth of all of the constituents, and the only source of wealth is production. If an American firm has $1 million on hand to buy foreign goods, it is only because they or someone else has already produced $1 million worth of wealth through production. The dollars are only valid for buying some type of American productive output, be it goods, services, government debt, factories, or anything else offered by the market. Ultimately, all of the dollars paid to firms in foreign countries must find their way back to America in one form or another, be it product sales or capital investment. They are no good in any country that doesn’t use dollars as the legal tender.
America has a trade deficit because Americans can buy stuff from foreigners for lower prices, and reducing the cost of living actually helps Americans. There are many reasons for trade deficits and surpluses between countries, including relative strength or weakness of national currencies, stability and growth of the economies, relative costs, and expected government interference. If you don’t want deficits, work on the causes and not on the symptom. One direct approach that the president can take to make American firms more competitive in both the world and domestic markets is to work toward reducing costs by further engaging in the war on taxes and government regulation that make companies less competitive. That would be a war that would actually help all Americans.