As the world awaits a China-U.S. trade deal, both the president and the American public should recognize that bilateral trade deficits are not of serious economic consequence, and the seemingly obvious conclusion that reducing large bilateral imbalances will lower the overall deficit is also wrong.
While a better trade deal with China will certainly be good for American purchasing power and choices, it is only the composition of the trade deficit rather than its size that will change.
{mosads}This point is easily illustrated. Viewing trade with a neighbor, such as Mexico, it may be that we import $100 of their goods, but as much as it desires American products, at some point, Mexicans may want American currency even more.
So instead of spending all $100 here (hence bilateral trade would be balanced), Mexico decides to keep $20, purchasing only $80 of our products. The result is an American trade deficit with Mexico of $20. This pattern is exactly the same for exchanges with all countries.
So as long as the world desires to save a portion of its accumulated dollars — simply for holding, trading with others, or investing — our trade account will perpetually be in deficit due to the desirability of the dollar as a currency.
The idea that foreigners demand dollars because they are a safe, universally-accepted store of value is a “no-brainer.” Just ask Latin Americans, Africans or Middle Easterners, including Iranians. Would anyone prefer to hold their savings in Argentine pesos or the Iranian rial rather than the U.S. dollar?
Indeed, it is estimated that over 70 percent of American dollars are held abroad. As long as the dollar remains a key currency, trade deficits must continue. Trade agreements are likely to change the composition of deficits (China smaller, Malaysia larger, etc.), but the numbers themselves will not change, even if the agreements are beneficial.
Further, as daunting as bilateral trade deficit numbers sound — $375 billion with China and $17 billion with Canada, for example — balanced trade values between nations is quite unnatural.
Just as the average American has “trade” deficits with the food store, medical practitioners, restaurants, etc., it would be similarly far-fetched to imagine any two countries having their trade needs being perfectly satisfied by equivalent values in bilateral exchanges.
With the exception of forced Soviet bloc trade under central planning, this just does not happen. And any agreements with China reducing the bilateral trade deficit, as ongoing negotiations suggest, will result in increased imports from other low-cost producers, who in turn will choose to hold some of those newly-earned dollars.
As long as the dollar remains a reserve currency (or the U.S. a desired investment location), trade deficits must continue — we are in a success trap!
Finally, overall trade balance is inconsistent with the president’s economic growth goals. The faster our GDP increases, the more we spend. This would include buying more from abroad, which also raises the trade deficit. As a country/western song goes: “You can’t have your Kate and Edith too.”
Donald L. Losman, PhD, teaches at the Elliott School for International Affairs. Maroun Medlej, PhD, is assistant professor of finance. Both are at the George Washington University.