Because the current account and the capital account add up to the total account, which is necessarily balanced, a deficit in the current account is always accompanied by an equal surplus in the capital account, and vice versa. A deficit or surplus in the current account cannot be explained or evaluated without simultaneous explanation and evaluation of an equal surplus or deficit in the capital account.
DBx: All protectionists, nearly all politicians, most pundits, and even many professors continue to obsess over one of the two accounts in the so-called “balance of payments.” The obsession is with the current account. Ignored is the capital account.
The reasons for this obsession are several. They include, perhaps above all, the contribution such an obsession makes to demagoguery on behalf of politically powerful producer groups seeking relief from the need to compete vigorously.
But simple economic ignorance is also part of the story. The current account is the account on which the values of a country’s imports and exports are recorded. It’s true that on the current account are recorded the values of some transactions and monetary flows other than those of imports and exports, thus making the trade deficit not really synonymous with the current-account deficit. But the obsession in the popular – and, hence, in the political – mind with imports (mistakenly thought to be a cost of trade) and exports (mistakenly thought to be the ultimate benefit of trade) turns all attention to the current account.
The fact that (to use as an example the United States) the U.S. trade deficit rises in August over July is all most people (think they) need to know in order to conclude that Americans’ commercial engagement with foreigners in August was worse for Americans than was Americans’ commercial engagement with foreigners in July. “Deficit,” after all, is a scary word.
Yet very few people pause to ask what foreigners did in August with the dollars that they did not spend that month on American exports. Did foreigners burn these dollars? (Of course not – and, by the way, too bad for us Americans, for that use by foreigners of dollars would be the best of all possible worlds, trade-wise, for Americans.) Did foreigners invest these dollars? Answer: yes.
Because dollars are eventually either spent or invested in the U.S., the increase in the U.S. trade deficit in August means that foreigners invested more in the U.S. during August than they invested in the U.S. during July (thus causing the U.S. capital-account surplus in August to rise above its July level – and rise by the exact amount as the rise in August of the U.S. current-account deficit).
Thus, fretting and moaning and screeching over the trade deficit (more precisely, the current-account deficit) amounts to fretting and moaning and screeching over the capital-account surplus. Yet why is an increase in foreign investment in the U.S. something to fret and moan and screech over? It’s true that one can spin tales of why such increased investment is evidence of economic problems in the U.S. But in reality the truth is that most of this increased foreign investment in the U.S. is evidence of U.S. economic strength, at least relative to other countries.
The big, real exception is foreign lending to Uncle Sam to help finance Uncle Sam’s chronic budget deficits. Yet if we Americans trust our government enough to allow it to restrict our peaceful trade with foreigners, why then should we distrust this same government’s fiscal decisions? People who trust Uncle Sam to restrict trade have no business pointing to that portion of the U.S. current-account deficit that consists of loans to Uncle Sam as evidence of U.S. economic problems.
In either case – whether foreign investment is done here in response to economic problems here or in response to economic promise here – it’s nearly impossible to tell a plausible story of how these investments themselves make us worse off. And yet all protectionists, nearly all politicians, most pundits, and even many professors stubbornly ignore all of the above points. They hear the term U.S. “trade deficit” and rush heedlessly to the wholly mistaken conclusion that American trade patterns and policy are deficient.