"A Trade Deficit Is Good"

One of the examples of the short-sightedness of American economists is their focus on numbers, the main number being Gross Domestic Product (“GDP”).  If GDP goes up, then that’s good; if GDP goes down, that’s bad irrespective of other occurrences in the economy.  

Most people see a trade deficit as money leaving the nation.  We buy more than we sell thereby resulting in a deficit.  But there are two sides to every equation.  The other side is the capital side.  What happens to the money that we spend?  It’s invested right back in our economy, in theory.  They either invest in dollars, or debt (i.e. they loan us the money that we use to buy their products) or in capital (i.e. they buy stocks or other assets in our economy).

Economists interpret a trade deficit not as us consuming more than we produce but as foreign investors investing in our economy.  If investors want to invest in our economy rather than anywhere else in the world, then that’s a sure sign that we have a healthy economy.  And it’s true.  Despite the recent short-term fluctuation, our economy has been very healthy, and investors have been investing here and making good profits.

Investment is good.  A worker with a shovel can dig a hole faster and accomplish more than a worker digging with his hands.  On a broader scale, a manufacturing plant in Tennessee can produce more cars than no manufacturing plant.  It provides jobs for Americans, and our GDP goes up.  Usually, investment is generated by savings.  Instead of going out to dinner or taking an expensive vacation, consumers save, pool their savings and use the money to build a manufacturing plant.  They get jobs and reap the profits.  If Japan decides to invest in a manufacturing plant in the U.S., then the result will be that the U.S. will produce more thereby increasing GDP.  U.S. workers get jobs, and Japan gets a profit at the end of the year.  Everyone benefits.

But common sense tells us that if you're consuming more than you're producing, then sooner or later you're going to end up bankrupt.  If you buy more than you sell, then you have to use your savings, and after your savings is expired, then you have to sell assets or borrow.  Imagine a family consuming in excess of its income.  If the trend continues for long enough, then the family's financial position will deteriorate.  If the family borrows to invest in a college education or a business, then yes, in the long run their income will increase and the trend will be reversed.  But if the family's borrowings don't result in increased income over time, then their financial position is worse.

While a trade deficit is a sign that the economy is good, I disagree that large trade deficits over the long term are good.  After three decades, the U.S. has gone from the largest creditor nation to the largest debtor nation in the world.  We often hear about the "national debt" which represents borrowings by the Federal Government.  But consumer debt and corporate debt are also so high that it's hard to fathom.  And yes, all this is due to the trade deficit, decades of consuming more than we produce.

And investment from abroad was not in addition to our savings, it replaced it.  We have not generated savings.  The consumer savings rate has been embarrassingly low over the past decades.  And with the money from abroad, we have not invested enough in productive assets.  The government itself wastes billions per year.  Much of its budget is in the form of outlays for Social Security and Medicare that make neither businesses nor workers more productive.  Bridges collapse.  A levy can't protect a city.  Dams are aging and in danger of collapse.  Consumers have borrowed to buy luxury automobiles, big screen TVs, vacations and houses they can't afford.  Had we used the investment from abroad in productive means, then we would have been better off.  But we're not

We misspent the money.  Not just Congress.  Not just the President.  WE DID IT!  You've got your Xbox and big screen TV, a big house, a BMW and nice clothes.  And you've got debt that you and your children and grandchildren will be paying off your entire lives.

Economists have used consumer spending as the engine of the economy for decades.  Consumers spend, business profit.  The more consumers spend, the more profits.  So policies have been created to encourage consumers to spend more.  Attracting foreign investment to replace the lack of domestic savings is only one method.  Another is Social Security.  Promise consumers a monthly annuity at retirement so they don’t have to save as much thereby creating incentives to spend.  Low interest rates made housing more affordable as well as credit cards.  Consumers are so burdened with debt and government obligations that it will take more than one generation to correct it.  The party is over.