Friday, January 11, 2008 - The Progress & Freedom Foundation Blog

Forget the Trade Deficit

Obsession over the trade deficit is one of the most dangerous pastimes of economists, politicians, and the press. It fuels anti-trade sentiment and tempts people to close our borders to capital and trade. This morning we hear that November's trade deficit "swelled" -- "widening to the biggest gap in 14 months."

Lou Dobbs and other anti-trade figures lead most people to believe that the trade deficit is the result of unfairly inexpensive imports from China. Protectionists and many manufacturers urge a weaker dollar to supposedly compensate for supposedly artificially weak foreign currencies and make American products more competitive. Well, over the last few years, the Fed has complied, and the protectionists have gotten their wish: a much weaker dollar. We've even seen American exports rise smartly. But guess what, none of that has helped the trade deficit. You can't get something for nothing, certainly not by manipulating the value of your currency.

Why has the trade deficit kept rising even as the dollar weakened and exports grew? Because by far the largest component of the rising deficit these last few years has been spiking petroleum imports. An inflationary dollar juiced oil prices to record highs. So foreigners could buy American products a bit more cheaply, but Americans had to buy oil at $70, $80, and now $90. Foreign beneficiaries are now attempting to reinvest those petrodollars back into the U.S. -- see Citigroup, Merrill Lynch, etc. -- if we will let them.

The simple rule of international economics is that you can't change the terms of trade by changing the unit of account. In other words, you can't increase competitiveness by devaluing your currency. Short-term gains are met or even outweighed by short-term losses, and over the long-term it's a wash or possibly an inflationary disaster.

America has enjoyed -- yes, enjoyed -- a trade deficit for 350 of the last 400 years. All it means is we've been a destination for capital. A trade deficit means a capital surplus. The last two times we "achieved" a trade surplus were in the recessions of 1990-91 and 1981-82. In my dictionary, trade surplus is a dirty word.

Lesson one: forget the trade deficit.

Lesson two: if you can't follow lesson one, remember that a trade deficit equals a capital surplus.

posted by Bret Swanson @ 9:43 AM | Trade