President Donald Trump wrongly thinks the trade deficit means the U.S. is losing at international trade. Yet in trying to prove him wrong, some critics make a misleading claim of their own: because trade deficits are matched by an inflow of foreign investment, they’re actually good.
In fact, foreign investment comes in different forms and for different reasons, some more desirable than others.
Trade deficits and foreign investment are linked through simple accounting. If Americans consume more than they produce, they will import more than they export. The resulting gap, combined with interest and dividend income, is called the current-account deficit, and must be financed by sales of assets, which is called a capital account surplus.
When you hear foreign investment, you may picture Toyota building factories, Ikea opening stores and BP drilling oil wells. But that’s only one type. More likely, foreigners will “invest” by purchasing Treasury bonds and bills, corporate bonds, stocks or bank deposits. Or rather than foreigners buying U.S. assets, it may mean Americans selling, or buying fewer, foreign assets. Usually, it’s some combination of all these things. And it does have a cost: Americans will be paying interest, dividends and rent to those foreign investors well into the future.
Is this good or bad? It depends. The U.S. ought to invest as much as possible in promising projects, whether homes, research or business. If Americans saved more and consumed less, there would be no trade deficit and no need for foreign investment; Americans would supply all the necessary capital and reap all the future returns. Since Americans save too little, it is better to finance those projects with foreign savings than to not finance them at all. As long as the return on the projects exceeds their cost of capital, the U.S. is better off.
There are good and bad ways to save more and consume less. A bad way is to have a recession, when Americans typically consume less and the trade deficit shrinks. But they also invest less, which subtracts from future growth.
A good way would be to shrink the federal budget deficit, which would force Americans to consume less, because their taxes rise or they receive fewer government services. Instead, Mr. Trump has presided over a historic expansion of the budget deficit. Thus, his two signature policies–protectionism and tax cuts–are working at cross purposes.
Yet how much Americans save is not entirely in their own hands. It is also influenced by how much foreigners save. In the mid-2000s, China pursued a policy of mercantilism: suppressing consumption and imports and promoting exports to produce huge trade surpluses and a corresponding capital account deficit, i.e. ravenous demand for foreign assets. Their preferred assets: U.S. Treasury and mortgage-backed bonds. This kept down U.S. interest rates, which discouraged Americans from saving and encouraged them to build houses, producing an inflated trade deficit and a housing bubble. In this case, both the trade deficit and the foreign investment that financed it were bad, not good for Americans.
The imbalances of the 2000s have shrunk but not disappeared: Germany and China still have structural trade surpluses that effectively force the U.S. and others to run trade deficits and therefore draw in foreign capital. Suppose Germany and China dramatically boosted consumption, investment and imports: the U.S. trade deficit would shrink. So would foreign investment; but no one would mind.
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from Real Time Economics https://ift.tt/2L6OZMZ
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