The Trade Deficit Narrows: Is it a Good Thing?
July 20, 2001

In 2000, the U.S. recorded its largest trade deficit: imports exceeded exports of goods and services by $376 billion. Such large numbers tend to excite attention, especially among the likes of Ross Perot and Pat Buchanan who regard growing trade deficits as the harbinger of imminent economic doom. If imports exceed exports, they claim, domestic unemployment will rise implacably as U.S. workers lose jobs to workers abroad.

There is a slight problem with such thinking: It simply is not supported by the data. For several years now, and especially during the boom years of the ‘90s, U.S. imports have consistently been greater than its exports, bringing into question the allegedly pernicious effect of trade deficits on employment.

There is another, more persuasive, argument about a potential problem with large trade deficits. It has to do with how such deficits are financed. When the U.S. imports $376 billion worth more goods and services that what it exports, it must be the case that foreigners–Europeans, Japanese, Chinese–are lending a roughly equivalent figure to the U.S. This “lending” takes several forms–German investors buying U.S. stocks, British companies acquiring American firms, Japanese banks investing in U.S. Treasury bonds–all of which necessitate future repayments by U.S. corporations and government to foreigners.

As long as foreign investors are willing to invest thus., the country can afford to run up big trade deficits. But if the domestic economy turns sour, leading investors to turn to greener pastures, the U.S. will no longer be able to enjoy imports sharply in excess of its exports as it finds itself unable to “borrow” the requisite amounts on world capital markets. At that juncture, exports and imports will have to come into some semblance of balance, orchestrated through changes in currency values and the like, none of which would be particularly pleasant for the U.S. economy.

Thus far, however, foreign investors have shown no inclination to reject the blandishments of U.S. capital markets. And so the trade deficit, at under 4 percent of gross domestic product (the economy's output of goods and services), does not appear to be unduly worrisome.

In 2001, the trade deficit continued to grow inexorably, at least for a while. Recent data, however, shows that in May, the trade deficit actually fell, fuelled by an increase in exports and a decrease in imports.

The rise in exports is a welcome sign. Despite the strong dollar (which raises the foreign prices of U.S. goods), the demand for U.S. products from overseas markets rose–an indication that the global economy may not be entirely supine yet.

The decline in imports, occurring at a time when the dollar is strong, is more problematic, for it suggests that U.S. consumers and firms, succumbing to the pall cast by the domestic economic slowdown, have reduced spending on goods and services.

It was precisely to prevent such a development that the Federal Reserve cut interest rates repeatedly since January 1. The apparent lack of the policy's effectiveness might spur Greenspan and Co. to cut rates yet again in the near future.