What you need to know about the trade deficit

What you need to know about the trade deficit

The US trade deficit is shrinking. The media say that's a good thing. Perhaps we can join Greece and Spain in running surpluses.

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WASHINGTON, June 12, 2015 — The trade deficit is shrinking, to some a cause for celebration. In spite of the fact that we are seeing more robust, though vacillating, employment numbers, there is no reason to add the shrinking trade deficit as a positive sign, in spite of the political rhetoric. Rather, it could be a harbinger of an economic reality that few will want to embrace.

Yet the media are proudly announcing the fact that the U.S. has a shrinking trade deficit.

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The balance of trade—the difference between the volumes of imports and exports—has been an obsession of those who are shallow in their economic knowledge and deep in their fear of competition. Many politicians claim that trade deficits (importing more than we export) are bad and demonstrate an economy in decline. As a result of decades of trade deficits, the U.S. is a “debtor nation,” a description that sounds grim.

So the shrinking trade deficit should be good news. The gap is narrowing is because the amount of goods we are importing each year is actually shrinking. This means that consumer demand is going down—not just for imports, but in general, because consumers are not really that discriminating.

In a recent interview, economic historian Brian Domitrovic told me that, when countries have trade surpluses, there is decreased interest among other nations in doing business with them. He pointed to the situation of the U.S. and Japan in the 1980s as a perfect example of this. While the U.S. bought Japanese goods in massive volumes during the 1980s, that country then used those U.S. dollars to buy American real estate. How was that harmful to the U.S.?

At the same time it ran huge trade surpluses, the Japanese economy began to show its frailty. The last decade of the 20th century and the first decade of this one were Japan’s “lost” decades, when its economy and living standards stagnated. Yet it continued to run trade surpluses.

When the economy is weak, we can’t afford to buy. Our trade deficit shrinks with our spending power.

In 1928, Republican Herbert Hoover was running against Democrat Al Smith of New York for the presidency. Hoover, the secretary of commerce under one of the most successful presidents in U.S. history, was running against a very popular governor.

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It was easy for Hoover to defend the record of the president he served, Calvin Coolidge, as virtually every indicator pointed to an administration noted for its prosperity. “A chicken in every pot and a car in every garage” was a message that rang true to most voters.

During the ’20s, Coolidge and his allies took a tax rate that was as high as 70 percent under their predecessor and lowered the top rate to 5 percent. Coolidge opened economic trade with countries and unleashed a level of prosperity we had not seen in generations. The number of people who made six-digit incomes—very high incomes in the 1920s—increased four-fold. Inflation was less than 2 percent and unemployment was equally low. They called it the “Roaring Twenties” for a reason.

Despite all the glitter, there were signs of “rust” for those who could not look beyond the obvious. The trade deficit grew rapidly during the Coolidge administration. Trade fell under the secretary of commerce, and Hoover was taunted by his opponent as the man who oversaw this area of “decline.” Finally Hoover got on the protectionist bandwagon and told voters that whether he or Smith was elected, there would be quotas and tariffs on trade. Hoover won, and in 1929 he was true to his promise of trade protectionism; he signed the Smoot-Hawley Tariff Act.

That law did exactly what it was supposed to do; it slashed the import of goods. Within a few years, the U.S. had its first trade surplus in decades and also one of the highest unemployment rates in history. The stock market crash that preceded the Depression was fueled by this trade protectionism. Wall Street knew that, if we penalized imports, foreign countries would retaliate. The market crashed because investors knew that the value of goods sold would decline as trade markets shrank.

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The trade surplus and the high unemployment rate were linked for a very simple reason: We imported more goods than we exported because our buying power had declined dramatically. Over the last century, our periods of highest prosperity were accompanied by eras of trade deficits. Trade surpluses accompanied economic decline. In our prosperity we were buying more, from everywhere, while foreigners valued our currency even more than they valued our goods.

Today, the shrinking trade deficit is a sign of systemic weakness. Our national buying power is in decline. Trade deficits continue to do what they have done for centuries—indicate flaws in a national economy and not a nation that is economically robust.

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