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A Gap in Understanding

Here’s a letter to MarketWatch:

Two major – if common – flaws mar your report today on the U.S. trade deficit (“U.S. trade deficit soars nearly 10% on record imports”).

First, to describe a trade deficit as a “gap” is highly misleading. It’s true that in July U.S. imports exceeded U.S. exports by $50.1 billion. But it’s also true that in July the amount of capital that non-Americans invested in America and in American assets exceeded the amount of capital that Americans invested abroad by $50.1 billion. That is, the (“current”) account on which goods and services trade is recorded is exactly balanced by the (“capital”) account on which investment flows are recorded.

And so to suggest – as your use of the word “gap” does – that a “deficit” in the first account indicates an overall deficiency in the health of U.S. trade, or that Americans lose something every time we run a trade deficit, implies that increased investment by foreigners in the U.S. is either economically insignificant or, worse, economically harmful. Because I suspect that you don’t believe that Americans are harmed when, say, Ikea builds a store in Cleveland or when the Taiwanese purchase shares in an IPO of an American company, I urge you to stop describing the trade deficit as a “gap.”

Second, you’re therefore mistaken to write that “the U.S. is growing rapidly despite a rising trade deficit.” “Despite?!” Because, again, a rising U.S. trade deficit is the same thing as a rising U.S. capital-account surplus, you here really say that “the U.S. is growing rapidly despite rising investment by foreigners in the U.S.” Unless you truly believe that increased investment by foreigners in a country is a drag on that country’s economic growth, you should from now on, whenever the U.S. trade deficit rises along with U.S. economic growth, write that “the U.S. is growing rapidly in part because of a rising trade deficit.”

Donald J. Boudreaux
Professor of Economics
Martha and Nelson Getchell Chair for the Study of Free Market Capitalism at the Mercatus Center
George Mason University
Fairfax, VA 22030

I thank my Mercatus Center colleague Christine McDaniel for alerting me to this MarketWatch report.