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Do Trade Deficits and Surpluses Matter?

Economics / Economic Theory Sep 21, 2012 - 08:11 AM GMT

By: Ian_R_Campbell

Economics

Best Financial Markets Analysis ArticleWhy read: Because I believe that where a country runs continuous net trade deficits and increasing net cumulative trade deficits that is a bad thing in the context of the economic well-being of that country. Others disagree, and in the current economic environment where the United States - still the world's most important economy - continuously:


  • runs monthly net trade deficits;

  • sees its cumulative net trade deficit grow to enormous levels; and,

  • sees its Federal Government run large annual deficits to the detriment of its cumulative National Debt balance,

this is something I think you ought to 'think for yourself' about and reach your own conclusion.

Commentary: As you know if you read this Newsletter, I have said more than once that:

  • the ongoing U.S. monthly and cumulative net trade deficits (which now stand average about U.S.$45 billion per month, and have consistently accumulated since 1973 to a current aggregate of about U.S.$8.5 trillion), are an important economic marker for me; and,

  • each month the U.S. experiences a further net trade deficit, I think that is a month where the U.S. weakens economically against its trading partners.

An article yesterday has prompted me to revisit my thinking on this. Having done that, my views are unchanged.

The article titled Andrew Coyne: Trade deficit Canada's newest economic hobgoblin, began with a sub-title 'A trade deficit can be as much a sign of strength as weakness', and went on to espouse the view that:

"The notion that trade deficits are some sort of economic blight, or that policy should aim at earning a trade surplus (invariably described in the press as "healthy") is perhaps the oldest of all economic fallacies."

The premise for that view was then expressed (as I read the article) as:

"The trade deficit, in other words, is only one part of our overall balance of payments. And the balance of payments must balance: whatever deficit we have on trade (technically, the current account, a broader measure that includes, for example, payments on investments) is necessarily offset by an equal and opposite surplus on the capital account. That's not an accident, or a wish. It's an accounting identity."

As best I can figure, the economic theory behind this statement (and the article's conclusion that trade deficits don't matter) likely is driven from a view that where a country has a trade deficit:

  • the currency of the country who has the trade deficit is received by its trading partner, which trading partner can then invest its 'trade surplus' back into the economy of the 'trade deficit' country. Note the operative word is 'can'. Can does not mean the same thing as 'will'; and,

  • as a result of this reinvestment, the country with the trade deficit will see its trade deficit exactly matched by capital surpluses equal to the reinvestment - and 'Bob will be your uncle'; or,

  • that reinvestment by the 'surplus country' in the 'deficit country' will not take place, and the currency exchange rate of the 'deficit country' will drop; and,

  • when the 'trade deficit' country's exchange rate drops, its goods and services will become cheaper and eventually it will return to having a 'trade surplus'.

See, for example Do trade deficits matter?, an August 2011 paper published by the Institute for Competitiveness and Prosperity (ICP).

The ICP article:

  • goes on to say that a country's trade deficit (or surplus) with a specific country is meaningless. It refers to a single cross-country deficit as a 'bilateral deficit'. This generally makes sense to me; but,

  • doesn't go so far as to say that a collective country trade deficit (or surplus) is meaningless. What it does say is that the U.S./China trade deficit is unprecedented, and that there are optimistic, middle ground, and pessimistic opinions about it.

The economic theory is obvious, and I think worthwhile to understand as an intellectual underpinning. That said, while I try to see things simply, I don't think that one can always push a number of very complex interactivities into neat and simple packages. For me, it is far to simple to say that 'a trade deficit is necessarily offset by an opposite surplus on the capital account', or that currency exchange rates in the end ultimately will result in trade surpluses offsetting current trade deficits. If that were true ( to site but two of what could be a large number of examples):

  • why would any country care if it lost its manufacturing jobs, and replaced them with service jobs or jobs that paid lower hourly rates; and,

  • how is it that the United States has run consecutive monthly trade deficits in every quarter from 1978, and in every month since 1992 (and likely long before that - prior data not available), in circumstances where the recipients of U.S.$ have to some degree reinvested those dollars in U.S. treasury bills - yet the U.S. continues to run trade deficits, high Federal Government deficits, faces high unemployment rates, and is not replacing its manufacturing jobs in part due to technological change.

Does Mr. Coyne's view find theoretical support among many economists? As best I know the answer is 'yes'.

Could it be right to say that Canada's recent monthly net trade deficits are "of no particular significance"? For sure that could be right if Canada reverts back to a monthly trade surplus, and does not find itself to be a 'United States' with a continuously building cumulative net trade deficits.

Could Mr. Coyne and the economists who hold to the 'economic balance theory' be right? I don't think so. I do think it is important, particularly if you participate in the financial markets, to think hard about whether you think the 'economic balance theory' as a practical matter is consistent with how our complex globalized world works.

For me, I plan to hold to my view that country-specific monthly net trade deficits and net cumulative trade deficits (and trade surpluses) indeed are important - and plan to continue to reflect that view in my own investment strategies.

Ian R. Campbell, FCA, FCBV, is a recognized Canadian business valuation authority who shares his perspective about the economy, mining and the oil & gas industry on each trading day. Ian is also the founder of Stock Research Portal, which provides stock market data, analysis and research on over 1,600 Mining and Oil & Gas Companies listed on the Toronto and Venture Exchanges. Ian can be contacted at icampbell@srddi.com

© 2012 Copyright Ian R. Campbell - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.


© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


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