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Trade deficits aren’t always bad

By Rachel Shey
web posted November 25, 2019

This summer I went to Chicago to visit my relatives.  While waiting for my cousins to show up, my family and I walked around the city and visited a few tchotchke shops.  I was dazzled by the prismatic representations of the Chicago skyline and by the toys, like a wired ceramic turtle that wobbled endearingly when moved.  While looking at the souvenirs, I noticed that all of them had a small sticker advertising that they had been “Made in China,” despite being Chicago-themed souvenirs, ironically.  This brings me to my point, which is that a trade deficit is good for a country.  Based on what we’ve seen in the Guns and Butter game, specialization is the way to go.  If China can produce consumer goods, like the souvenirs I saw in Chicago, more cheaply, why not take advantage of that and end up with more goods for less money? 

Milton Friedman argued for this interpretation by explaining that what we gain in foreign trade is what we import.  We cannot eat money.  Money has no commodity value; in fact, money is far less tangible than even the symbolic green bills that we exchange at stores; large amounts of it can materialize from thin air and correspondingly disappear.  Yet we can eat imported rice, we can use imported sewing machines, and we can drive imported cars.  Therefore, it is a benefit when we can import more goods in return for exporting less, because the goods and services that we export are goods and services we cannot use.  Analogize world trading to an exchange between two goat herders.  One wants a brown speckled goat that the other has; the other wants the fat goat that the first has.  In order to obtain the larger, fatter goat, the first goat herder must exchange the brown speckled goat in addition to some money, whereas the second merely provides the fat goat.  In terms of goats, the first goat herder has a surplus; in terms of money, the first goat herder has a deficit.  In terms of goats, the second goat herder has a deficit; in terms of money, the second goat herder has a surplus.  Therefore, America may be running a “trade deficit” in terms of money, but we actually have a “stuff surplus” because we’re letting other countries specialize and do our work for us.  In the end, the balance is even; the goat herders exchanged items of equal value.  Neither party was “scammed” or “stolen from.”  Friedman further notes that currency will always come back to a country in the long run, such as through foreign investment. 

The $375 billion outflow of money from the US to China is a trade deficit, but it also equals a $375 billion inflow of stuff from China to the US, goods that the Chinese people make, but cannot enjoy or use.  In terms of standard of living, the Chinese have far lower standards than the US.  This is likely because of their “stuff deficit.”  In fact, China has recently been undergoing pork and water shortages, so they clearly have lower living standards than the US.

Some people are concerned that the US is losing jobs to China, because without demand for domestic goods, domestic manufacturing jobs disappear.  Trump stated in his State of the Union that “We are now making it clear to China that after years of targeting our industries, and stealing our intellectual property, the theft of American jobs and wealth has come to an end.”  Is China really stealing American jobs and wealth?  When a trade deficit arises, there is an equal rise in money (foreigners borrowing money by purchasing bonds, real estate, or stocks in the deficit country), which means that more jobs are created in those other industries.  The influx of goods, too, means an expansion of retail; in the past, that might have meant a new mall opening; today, it might look more like a new Amazon fulfillment center.  Therefore, although some job losses will occur, other jobs are created to fill those holes.  During the adjustment period, unemployment will rise, as it takes time for workers to move to other industries, which temporarily makes the argument that domestic jobs are being stolen look more truthful than it really is.  Statistics show that as trade deficits rise, unemployment actually lowers; and as trade deficits lower, unemployment goes up.  Therefore, trade deficits are not necessarily bad for the economy as a whole. 

How do trade deficits affect the bigger-picture demand forces in an economy?  Demand for a country’s exports affects the value of its currency.  If the US exports many goods to another country, such as South Africa, the value of the dollar rises against the value of the rand, because demand for American goods rises in comparison to demand for South African goods (as demand increases, price increases).  Therefore, in the trade deficit with China, the dollar will become devalued compared to the yuan.  Indeed, statistics illustrate that over time, the dollar versus the yuan is weakening.  What does this mean?  A weaker dollar makes imports more expensive for consumers; this makes foreign travel and other essentials like fruits and vegetables more expensive. A weaker dollar also makes production more expensive.  However, Trump has also stated that the US central bank should weaken the dollar to match Russia and China’s alleged “currency manipulation,” as weakening the dollar will create more favorable conditions for exports and briefly enhance output.  In practice, however, the US government should not try to pursue either a weak or a strong dollar; while currency depreciation provides a short term boost for output, this is quickly cancelled out by rising inflation and declining consumption.  When currency depreciates, aggregate demand increases. 

A final consideration is that the US economy is one of the world’s biggest, and its dollar is the world’s reserve currency.  As a result, demand for the dollar has remained quite strong despite deficits, so it’s unlikely that the dollar will become extremely weak or that inflation will become a threat as a result of the trade deficit. 

As a political aside, I don’t disagree with the trade war.  The issue with China is not only a trade deficit, but politics and ideology, such as Uighur re-education camps, Hong Kong, and its social credit system.  In addition, China has also been labeled as a currency manipulator and engaging in other unfair trade practices, such as theft of intellectual property.  The real winner in the trade war is Vietnam, because rather than moving production to the US, manufacturers are heading to Vietnam, where goods can be produced more cheaply than in China. 

Ultimately, trade deficits aren’t necessarily bad.  It’s not always true that “American jobs are being stolen by China,” and the solution to the loss of manufacturing jobs is not to attempt reclamation of the past but to lean into the current economy’s strengths.  America has a surplus in entertainment with nearly every country; we also have a free economy that promotes innovation.  A decrease in manufacturing jobs means an increase in another field; the economy overall is not losing jobs. ESR

© 2019 Rachel Shey

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