The Perils Of A Trade War

Michael Kurth Thursday, July 5, 2018 Comments Off on The Perils Of A Trade War
The Perils Of A Trade War

Shortly after President Trump took office, he told reporters he had asked his staff to find a country where we actually do well in foreign trade and there wasn’t any. “It’s just losses with everybody, and we’re going to turn that around,” he proclaimed.  

Economists around the world cringed as it became clear that the president was judging the value of our trade relations by the size of our trade deficits with our trade partners. He believes that if we have a trade deficit with a country we are getting ripped off, and if we have a trade surplus we are “winning.” But that is not how trade works.

This will probably come as a shock to many people, but trade is always balanced. The terms “trade deficit” and “trade surplus” are simply jargon used in the balance of trade accounting where transactions between individuals, companies and government agencies in different countries are recorded. The balance of trade ledger has two sides: the current account that tracks the movement of goods and services; and the capital account that tracks the movement of money and other financial instruments. These two accounts must balance. So, if there is a deficit in one account, there must be an equal surplus in the other account. 

To understand how this works, imagine that your family is its own little country. You need a new car, so you go to a dealer and give him $30,000 and you drive home in your new vehicle.  According to balance of trade accounting, your family has just imported a car and it now has a $30,000 trade deficit. Was that car a bad deal? Did you get ripped off? Does the dealer have to buy $30,000 worth of goods from you in order for your trade to be balanced and fair? 

The movement of goods is only half the story; the other half is the $30,000 you gave the dealer. That payment was recorded as a surplus in your capital account. Thus, to say you have a trade deficit is the same as saying you have a surplus in your capital account, because the two are equal by definition.   

Now, let’s apply this to trade with China. Suppose U.S. consumers buy a billion dollars’ worth of plasma TVs from China. The Chinese ship us the TVs, and we pay them their billion dollars. We now have a billion-dollar trade deficit with China. But we also have a billion-dollar surplus in our capital account. Do the Chinese have to buy a billion dollars’ worth of our goods for this to be a “fair” deal? If they don’t, what are they doing with the money? It would be nice for us if they used our dollars as wallpaper or fed them to pigs because we would be doing quite well to trade pieces of paper for plasma TVs.

There are only a couple of things the Chinese can do with this money. One is they could use it to buy goods from another country. But if we wanted to do something about that, we would have to ask them what they were going to do with our dollars. Chances are they would use them to buy our goods. But if they don’t, and the money is just being passed from hand to hand, country-to-country, and never used to buy our products, it would be almost as good as the Chinese feeding the money to the pigs: we would still be getting plasma TVs for pieces of paper.

Another thing the Chinese could do with the money is that they could bring it here and invest it in the U.S.; this also would be good for us because it would help our economy grow. Or they could use it to buy our government bonds, which, in fact, is what the Chinese have been doing with it. China currently owns $1.2 trillion in U.S. government bonds, which is equivalent to three years’ worth of their trade deficit. And it’s not just the Chinese who are buying our government’s debt: our federal government now owes over $6 trillion dollars overseas, which is equivalent to our entire trade deficit since 2006.  

So the question is this: if President Trump’s goal is to eliminate our trade deficit — or better still, have a positive trade balance with all our trading partners — where is the money going to come from to finance our federal government? Blaming trade deficits on bad trade deals may sell with some voters. But the simple fact is that our federal government has been exporting its debt overseas where it competes for the same dollars as our goods and services. Balance the federal budget and the trade deficit will largely disappear.

Waging a trade war to reduce our trade deficits is most likely to: (a) increase the price of imported goods for American consumers; (b) reduce the volume of global trade; (c) depress the value of the dollar; and (d) drive up interest rates. Some domestic industries may benefit from a trade war through increased demand for their products. But other industries in the export sector will suffer.

Lake Charles has one of the most export-intensive economies in the U.S. And guess who our No. 1 trading partner is. Yup, it’s China, and we even have a trade surplus with them.  

So get ready. We may very well find ourselves on the frontlines of the trade war.

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