The United States runs a trade deficit whenever, during some time period, Americans import more goods and services than they export. Yet each time Americans import more than they export, foreigners invest more in America than Americans invest abroad. The reason is simple: because foreigners who wish to invest in America need dollars to do so, they can’t spend all of their dollars buying American exports. It follows that as foreigners’ eagerness to invest in America intensifies, their eagerness to buy American exports diminishes — thus causing US trade deficits to rise.
This net inflow of investment funds to America balances out the trade deficit (or, more precisely, the current-account deficit). Because investing is every bit as much an economic activity as is buying (importing) and selling (exporting), when investing is included in the economic picture — as it should be — the existence of a trade deficit signals neither decline nor imbalance. Countries, such as the US, that consistently attract a disproportionately large share of investment funds from around the world can hardly be said to be on the decline or unbalanced.
This simple reality, however, is stubbornly ignored by protectionists. The negative connotation conveyed by the term “trade deficit” is so very useful to the protectionist cause that protectionists seem to have no interest in getting their — or their audiences’ — thinking straight about this concept.
Although an obstacle to economic understanding and to an acceptance of free trade, the term “trade deficit” in particular — and, more generally, the concept of “balance of payments” — will unfortunately remain available to protectionists as a means of deceiving the economically uninformed into a self-destructive hostility toward free trade. As noted by the great economic historian Robert Higgs, “the international balance of payments has to be the most nonsensical accounting statement ever devised, serving no purpose but to justify to gullible people the government’s pernicious application of force and fraud as if its so-called protectionism were a benefit to the general public.”
The concept of a “trade deficit” sows even more confusion when it is used to describe, not one country’s economic engagement with the rest of the world, but one country’s economic engagement with one other particular country. As confusing as is the term “US trade deficit” when used to describe America’s economic engagement with all other countries, at least this term conveys economically meaningful content to people who understand economics. If, for example, the US in 2024 runs in a trade deficit of $900 billion, this fact tells us that America in 2024 was a net recipient of $900 billion of investment funds from around the world.
In contrast, when someone speaks of, say, “the US trade deficit with China,” absolutely no economically meaningful content is conveyed. In a world of more than two countries, the trade that the peoples of any pair of countries have with each other has no economic relevance whatsoever. Bilateral trade deficits or surpluses are economically meaningless.
We know what a protectionist such as Oren Cass refers to when, for example, he complains that the “US-China trading relationship became the most imbalanced in world history.” He refers to the value of American imports from China far exceeding the value of American exports to China. According to Cass and other protectionists, we Americans are therefore supposed to be alarmed. But the only alarming thing about Cass’s complaint is the gross economic misunderstanding that it reflects and fuels.
Even if we disregard the possibility that the Chinese are investing in America some of the dollars they earn by exporting to America, there’s no reason whatsoever to suppose that any two countries in our world of nearly two-hundred countries will buy and sell to each other the same amounts. Such an outcome could happen, but, were it to do so, it would be bizarre and surprising.
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