A $44B trade deficit sounds scary, but it’s really a fiction

Put the words “trade” and “deficit” together and you’ll get lots of people who call themselves fiscal conservatives in a tizzy. The word deficit sounds pretty scary. If we’re talking about the Federal budget or someone’s personal bank account, fear about persistent deficits may be warranted, but regarding trade it does not matter. Why not?

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The Commerce Department released numbers on Wednesday showing that US imports totaled $232B with exports $188.6B. The difference is the so-called deficit. But what does the difference really mean? It means that the US exported 232 billion US dollars in exchange for imports, but only absorbed 188.6 billion US dollars in exchange for goods. All it means is that 44 billion currency units were shipped out of the country on net. So what?

If would be one thing if those dollars had to be redeemed for something, if the dollars were claims on some commodity that had to be paid, but they aren’t. There is no gold standard anymore, so they just sit there, in wherever country they were sent to in exchange for imports. Dollars are created by fiat, so no actual resources are expended in bringing these dollars into existence. The result is essentially $44B of “free stuff”.

An apt analogy would be a “trade deficit” between New York and Texas. Whoever ends up with more dollars and less stuff between the two would have the surplus. Whoever ends up with more stuff and less dollars would have the deficit. But it doesn’t matter who has what, because at the end of the day neither New York nor Texas would owe anything to the other, as all accounts are settled in either dollars or stuff.

Deficits only matter when accounts are not settled, for example when something is owed in the future as in a debt exchange. A deficit in the Federal budget is an issue because the deficits are financed by debt, which is owed later, and in the end that debt is paid by the public that is taxed directly or has its currency inflated to redeem the debt.

The real danger of a trade deficit is only indirect, in that when an economy gets used to exporting non-redeemable paper on net in exchange for stuff, it can get complacent and will have a hard time adjusting if the other side stops accepting the paper. In monetary parlance, if the value of the dollar plummets and can no longer finance the same amount of imports. The other danger, which is related, is what happens when all the net dollars exported come back to the US? High inflation would be the inevitable result.

So while there is nothing bad about a $44B trade deficit, the real trouble will only come when foreign countries stop absorbing these dollars the US prints in exchange for the things they produce.

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