Trade Deficits Signal Confidence, Not Decline

Donald J. Boudreaux

Two weeks ago I told a simple yet realistic tale of You running a trade surplus with Non-Youers (that is, with people who aren’t you – with people outside of your own household).  Here I tell an equally simple and equally realistic, yet different, tale of You and Non-youers.Does your trade deficit with non-youers signal that you are economically irresponsible? Of course not!
You have just become the proud parent of new-born triplets, so you can no longer save as you once did.  Every cent of your pay now goes toward paying your current expenses.  In other words, you stop running a trade surplus with non-youers; you now buy as much from non-youers as non-youers buy from you.  One night, while awake tending to your new bundles of joy, you are struck with an entrepreneurial idea for a new product that you believe has a good chance of earning you a small fortune if that product can be manufactured and distributed to consumers.



The next morning you tell your neighbor (a non-youer) about your idea.  Your neighbor is impressed; she shares your enthusiasm for the idea.
“But I have no funds to spare to start this new business,” you confess with a sigh to your neighbor.  “And to develop and perfect this new product will likely take five years.  It’ll be five years before I’ll have the new product ready to offer for sale to consumers.”
“Worry not,” your neighbor replies, “I’ll lend you $1,000,000 of my funds.  I’ll charge you six percent simply annual interest, with final payment due no later than ten years from today.  Once each year, starting today and then for each of the next four years on this date, I’ll transfer to you $200,000.”
You thank your neighbor profusely and shake her hand warmly.  You’ve got at deal on the terms your neighbor proposes.
Your neighbor pulls out her smart phone and immediately transfers $200 grand to your checking account.  You proceed to spend these funds on the development of the new product that you predict will, starting five years from now, prove to be a profitable source of steady income for you and your family.
The Trade Deficit
During these five years of your new enterprise, you have a trade deficit with non-youers.  You now spend more than you earn in current income.  You spend all of your current income on consumption items for you, your spouse, and your growing bundles-of-joy, and you spend an additional, borrowed $200,000 annually developing and perfecting your new product.
Politicians and pundits assume that if Americans run a trade deficit with non-Americans, then Americans are irresponsible.
Does your trade deficit with non-youers signal that you are economically irresponsible?  Does this trade deficit that you have with non-youers imply that non-youers are craftily and greedily taking economic advantage of you?  Is your trade deficit today with non-youers a prelude to your economic decline tomorrow?  Will your trade deficit today with non-youers necessarily be followed tomorrow by a reduction in your and your family’s net worth?  Would your and your family’s economic future be brighter had you not accepted into your household funds from non-youers – funds that came to you from an exchange other than you selling, in the current period, goods or services to non-youers?
The answer to each of these questions is, of course, “Of course not.”
And yet if typical discussions by politicians and pundits of America’s trade deficit are taken seriously, the answers must instead be “Yes.”  Politicians and pundits simply assume that if Americans run a trade deficit with non-Americans, then Americans are irresponsibly allowing themselves to be taken advantage of by crafty, greedy, and unfair non-Americans, and that the result will be economic decline for Americans.  But if you (!) believe that the trade deficit that you run, in the above example, with non-youers is both a signal of non-youers’ confidence in your economic prospects and a source of your future economic betterment, then you should reject the common claims and implications that a U.S. trade deficit is necessarily both a signal and a source of U.S. economic decline.
Trade Deficits and Debt
Contrary to popular myth, a trade deficit need not become debt.
In the above example you borrowed money from non-youers.  In this particular example, then, your trade deficit with non-youers does indeed become debt that you owe to non-youers.  But – also contrary to popular myth – a trade deficit need not become debt.  Suppose, alternatively, that your neighbor agrees to advance to you the same $1,000,000, not as debt, but as the price of her buying half ownership in the company that you found to develop and sell your innovative new product.
In this alternative arrangement, you owe your neighbor nothing (except, perhaps, gratitude!).  In this alternative arrangement, you do not become indebted to your neighbor: if your partnership company succeeds, she owns half the value of the company and receives half of its profits, but you owe her nothing (except thanks – which she also owes to you!); if your partnership company utterly fails, she loses her $1,000,000, but you owe her nothing (except, perhaps, an apology for having failed to deliver a profitable product after she agreed to risk as equity $1M of her funds on your entrepreneurial idea).
I hope you get the picture.