Something was bothering Dave Hoeft. A student in my class in international finance, Dave had read an article in the Wall Street Journal describing the U.S. trade balance. The current account deficit for 1997, the article stated, was $166 billion. (Essentially, this meant that the imports of foreign goods and services by U.S. consumers exceeded U.S. exports to other countries by 166 billion dollars.)
The figure was huge, no doubt. A hundred and sixty-six billion is not exactly small change. So was this large trade imbalance cause for alarm? Did this portend trouble for the U.S. economy?
Upon closer inspection, Dave realized that the magnitude of the trade deficit reflected the underlying strength of the U.S. economy. Last year, while Europe grew slowly and Japan continued to languish, the U.S. economy chugged along briskly, adding about 300,000 new jobs each month. As household incomes rose, consumers stepped up their purchases of goods and services, some of which came from abroad. This increase in imports, Dave noted, lay behind the widening of the U.S. trade deficit last year.
So the large trade deficit was actually the result of a vibrant economy. Hardly grounds for gloom, one would think. Yet, noted Dave alertly, the Wall Street Journal article had mentioned that the trade deficit had "worsened" in 1997.
The use of the word "worsened" to indicate an increase in the trade deficit is worrisome. Although hardly puzzling - for there is a general presumption in certain quarters, including the financial press, that trade deficits are bad. Somehow, if our purchases from other countries are greater than their purchases from us, we are in imminent danger of some kind of economic catastrophe. By the same token, then, a country with a large trade surplus should be sitting pretty. Oh, really? One look at Japan's economic malaise, despite its gargantuan annual trade surpluses, should dispel that illusion.
Trade deficits are neither bad nor good. They merely reflect a country's desire to consume (and invest in capital goods) in excess of its production. You can run a trade deficit as long as foreigners are willing to lend you the amount needed to finance the excess of your imports over exports. Since the early 1980s, the U.S. has attracted dollops of foreign investment, and that is precisely what has enabled the U.S. to run sizeable trade deficits in all these years. And, though we have been hearing dismal accounts of imminent doom for the last many years, these trade deficits have not prevented the U.S. from enjoying a protracted period of sturdy economic growth, quiescent inflation and low interest rates. The prophets of doom, including the likes of Ross Perot and Pat Buchanan, must be suffering in mortified silence. Perhaps.
But the worry about trade deficits is unlikely to dissipate soon. As long as East Asia, including Japan, remains mired in a recession, U.S. exports to that region will suffer. Compounding the trouble is the recent depreciation of the currencies in South Korea, Indonesia, Malaysia, Thailand and the Philippines. As their currency values have plummeted, so have their purchasing power - with adverse consequences for U.S. exports to these countries.
As the U.S. trade deficit widens yet again in the coming months - as is likely - there will be the usual cries of consternation. More worryingly, there are likely to be calls for the adoption of protectionist policies to keep out foreign goods, a move that would impoverish both the U.S. and its trading partners. Now that is cause for concern.