International trade has emerged as an important issue in the past several years, as the longstanding consensus on free and open trade has come under attack from all both ends of the political spectrum.
On November 4 the U.S. Bureau of Economic Analysis released trade figures for September, showing that the pandemic continues to have a major negative impact on trade, especially trade in services. Although localized trade data is very unreliable—it’s never clear exactly what is being counted—we do know that the Puget Sound area and Washington state are among the most trade dependent in the nation, so we have a big stake in this.
Persistent trade deficits have been a feature of the U.S. economy since the mid-1980s and have deepened since the mid-1990s. Figure 1 shows annual imports, exports and the net trade balance, for goods and services combined, since 1960.
While two-way trade grew through the 1960s and 1970s, flows remained fairly balanced. The industrial economies of the world were still completing their rebuilding after World War II and did not pose a great threat to U.S. producers. By the 1980s, that rebuilding was largely complete, and industries in Europe and Japan were turning out very attractive products. U.S. exports were growing too, but deficits began to creep into the picture. Then, by the early 2000s, deficits started getting really big.
While trade was expanding and the trade deficit was growing in dollar terms, the U.S. economy was growing too. Figure 2 shows the trade patterns from Figure 1 as a share of gross domestic product.
Viewed this way, the deficit trend is less clear. Trade was a major issue in the 1980s, and we can see why, as the trade deficit shot up from less than one percent to nearly 4 percent of GDP. The deficit dropped in the 1990s as exports picked up. But by the late 1990s and 2000s exports were stagnating while imports surged and the trade deficit shot up to 5.5 percent of GDP by 2006. The Great Recession put a damper on imports while exports again increased, leading to the relatively steady 3 percent trade deficit of the past decade.
Trade balances (surplus or deficit) are complicated to unravel. The competitiveness of industries is certainly a factor—we really love Japanese cars and Japanese buyers don’t have much use for American cars—but not the only one. For nearly all countries in the world, trade deficits lead to drops in currency values, so that imports become more expensive, exports become more competitive, and trade can return to balance.
But the U.S. is different. We have the world’s preferred reserve currency, and we offer abundant opportunities for profitable investment. So when we flood the world with dollars by buying more goods and services than we sell, overseas investors soak up those dollars to buy bonds, stocks, real estate and other asset classes. The dollar just won’t fall very far even in the face of massive trade deficits because the surplus dollars from trade are in demand for other transactions.
If we think of international commerce as having four components–goods, services, income, investments—the accounts always balance. (Every dollar traded for foreign currency needed to buy somethings outside the U.S. is a dollar used by a foreigner to buy something in the U.S. Currency exchange markets ensure this balance is maintained.) Figure 3 shows these four categories of transactions for 2019.
We see a big deficit in the sale of goods. This is somewhat made up for by a surplus in the sale of services and by the fact that Americans earn slightly more abroad (mostly investment income) than foreigners earn in the U.S. The balance of the total of those three categories gives us the “current account” deficit, and this is offset by investment flows, the dark green bar–the capital account surplus. A lot more investment money comes into the U.S. than goes out.
Since the U.S. began to run large government deficits in the early 1980s, and foreign investors bought all those Treasury bonds, economists have been warning that bad things were going to happen. As foreign buyers of U.S. bonds and other investments piled up their holdings, we became more and more beholden to people outside the country and our trade deficits kept growing.
When the economist Herb Stein famously observed that “if something cannot go on forever, it will stop,” he was thinking about this very dilemma. But so far, the “unsustainable” current account deficits and capital account surpluses show no signs of stopping. Stein’s day of reckoning is out there somewhere, but it might not be wise to place bets on the timing.