Trade Deficits, Surpluses Jude Wanniski February 7, 1997

Supply-Side Economic Lesson No. 10

Memo To: Website Students
From: Jude Wanniski
Re: Trade deficits, surpluses

Several questions have asked whether trade deficits are good or bad. Here are some basic considerations.

When you run a trade deficit it simply means you have bought something on credit. You import goods that you will consume and in return give an IOU, to the person or company or country that has sold you the goods on credit. They have to be willing to sell you goods on credit for the deficit to occur. In international trade, a country incurs a trade deficit when the total amount of goods it sells to the rest of the world (ROW) in a given time period — usually a calendar year — is less than the amount it buys from ROW. If it sells X and buys Y, its deficit is Y - X. There can be no deficit in its balance of payments with ROW, though, because no country can acquire goods without either cash or credit, or as an outright gift of goods, which do not appear on its international accounts.

Step back and think of yourself as an economic body. When you come into the world, you are unable to produce goods and services. You are a total consumer of goods and services. You run a trade deficit with your parents, who are producing enough G&S to sustain themselves and you, their baby. In your teenage years, you are working at a job and earning income, but as far as the economy is concerned, you are still running a deficit. You are still living off your parents, minus the amount you are earning yourself. In dollar terms, the trade deficit is surely larger, because you are full grown and consume much more, including tuition at school.

In this way, think of yourself as a net debtor to your parents and society in general until you are about 35 years old. You may have come out of school at age 20, but you still "owe" everything you have consumed in your early years, and are probably adding to that debt, if you buy a car on credit or buy a home with a mortgage attached. It is not until you are in your mid-years, your most productive, that you are beginning to run an annual trade surplus with your ROW, paying down your debts little by little. Sometime in your late 40s, you have probably liquidated all the trade deficits of your youth, which includes raising children of your own. From then on, your trade surpluses with ROW are going to help your parents in their last years alive, and to accumulate sufficient lOUs from the ROW with which to see yourself and your spouse to the end of your lives. Your accounts are clear at the end of your lives.

Is a trade deficit good or bad? You see, it is not at all clear that the question can be answered that simply without further consideration.

An individual's trade deficit with the ROW is absolutely necessary. A country, which is a collection of individual people, can get along with or without a trade deficit, in the sense that if it were the only country in the world, it could not exchange G&S for credit with the ROW. In a larger sense, the world cannot run a trade deficit or surplus with itself. As a student of economics, you should be aware that statistics on trade are so pitiful that if you add up all the trade deficits in the world, you will find that the world runs a large trade deficit with itself. The reason for the errors in the collection of data is that every country taxes imports and does not tax exports. So each country has a good record of what is coming in, but does not care that much on what goes out. The U.S. trade deficit with the ROW is enormous each year partly because the federal government is able to count physical things coming into the country, like cars and shoes, but loses track of the intangible things going out of the country, for big bucks, like telecommunication charges, software sales, entertainment, education of foreign students. Also, a lot of the stuff we are importing consists of capital goods, which make cars and shoes. These count as part of our trade deficit even though it is the Japanese or Koreans or Germans who are selling us more cars and shoes than they are buying G&S from us — so they could get the dollars their U.S. affiliates need to buy the capital goods and set them up here.

Japan has been in the news for years as being a bad trading partner, because it sells us more than it buys from us — running large trade surpluses. Think of Japan as a person, though, and go back to its childhood, after it emerged from WWn, almost as helpless as a newborn babe. For many years, into the 1960s, Japan bought more from the ROW than it sold, because all it had to sell to foreigners were lOUs — stocks and bonds and real estate, and a reputation for being very productive once they got up and running. Indeed, in the 1950s, there were Americans criticizing Japan for running a trade deficit with us, by taking capital from us in exchange for their lOUs. The numbers of dollars involved were smaller back then, but back then an ounce of gold cost $35 and now it costs $350. Our government really can't tell how much our investments way back then are continuing to rise in value inside Japan, paying dividends that return to us in the form of cars and cameras and tv sets. In other words, some significant portion of the Hondas and Toyotas we are driving are not being paid for on credit, but are coming in as dividends.

Just as an individual goes from cradle to grave, a country like Japan  has a demographic cycle. Its people are now aging faster than we are, in the sense that a higher fraction of its population will be retiring in the years just ahead, while our baby boomers will not begin to go over the bend until 2012. This means that Japan's trade surplus with the ROW will now tend to decline, as its population produces a bit less and consumes a bit more — other things being equal. Japan also has had a net emigration for the last generation — its better-off people taking their wealth and moving to other countries, where there is more elbow room for them. When a Japanese person migrates to another country, taking his assets with him, the flow of assets show up in the statistics as a trade surplus for Japan. When Rupert Murdoch, the Australian billionaire, moved to New York and changed his citizenship to American, his transfer of assets showed up in our stats as a trade deficit!!

A trade deficit can really be bad for a country if its government borrows money for G&S from the ROW on government credit, and then spends the money unwisely, which governments tend to do. Mexico's trade deficits in the late 1970s into 1980 were bad, because the government was borrowing dollars that it quickly spent, on the promise it would pay back its loans with government oil. The government speculated that oil would rise to $40 a barrel. When it dropped to $20 a barrel, the government could not meet its foreign bank debt. On the other hand, when Mexico ran a trade deficit from 1989 to 1993, it was a good deficit, because private individuals in Mexico were importing goods and services from private individuals in the ROW, especially the U.S., in exchange for private stocks and bonds. Mexico was building its private economy. It was only when the Mexican government screwed up in December 1994, devaluing the peso by 50%, that it made a mess of its economy. Instead of becoming richer through growth, Mexico suddenly went into economic decline, as the financial bonds of trust embodied in the peso were shattered. From that moment on, Mexico began running a trade surplus with the United States instead of a trade deficit. That is, it had to sell goods to us at fire-sale prices to meet its dollar obligations, and it was no longer in a position to buy from us on credit, as we had lost confidence in Mexico.

There are a great many aspects to international trade and capital flows we will get into in the course of these little lessons. This should serve as a start, hopefully inviting some good questions from the growing class.