Tags: trade deficit | tariffs | trade war | trump | china | mexico

Why Should We Care About the Trade Deficit?

Why Should We Care About the Trade Deficit?
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Wednesday, 22 August 2018 12:33 PM Current | Bio | Archive

What is a trade deficit and why should we care?

As tariffs start to bite, and the threat of an all-out trade war looms large, we should take a look at how we got here and what to expect.

The reason the U.S. has a trade deficit is twofold. Firstly, the cost of production is lower in many other countries than in America. This results in production moving to places like Mexico and China. On its own this would not be a problem. If the U.S. produced a sufficient amount of other goods and sold them abroad it could fund purchasing of foreign goods. However, the second part of the problem is that America is trusted enough globally to be lent enormous sums of dollars. This allows consumption to occur here even though production does not. So how is this consumption funded or paid for with out the proceeds of production? The answer is credit.

In layman’s terms, America has stopped working and is living on its credit card.

Trump has, in his own words, introduced barriers in an attempt to force other countries to renegotiate trade agreements. This is because America has long suffered a balance of payments deficit, meaning more goods are imported than exported. At an emotional or intuitive level tariffs sound like a good idea. When we make Chinese steel or German cars more expensive, domestic equivalents will become relatively cheaper, and therefore more popular. This will drive demand and increase domestic production. If the Chinese retaliate, we will retaliate twofold. Eventually they will cave and stop undercutting American producers.

Unfortunately it is not that simple. International trade is not the same as regular business dealings and consequences take longer to materialize. Putting up barriers will not solve the cause of the problem, instead they just look to address the symptoms.

The risks associated with driving a hard bargain in, say, property negotiations range from more minor costs like paying interest on a bridging loan up to the more extreme case of a potential buyer walking away from a deal. In the complex world of international trade, the consequences are multiplied almost infinitely and they become impossible to map. It is important to note here that international trade is not complex because any one part is difficult to grasp, rather the sheer volume of players and interactions is beyond comprehension. In short, it is the difference between micro- and macro-economics.

Unfortunately, the recent job losses at Mid-Continental Nail in Missouri are a good indication of what we can expect. The goal of the well intentioned steel tariff, by making imports more expensive, was to increase demand for domestic steel. The result was the United States' largest nail manufacturer laying off almost a third of its staff due to increased costs.

What if a full on trade war delayed or altered the Chinese corporation Foxconn's $10 billion plans in Wisconsin, or caused a slowdown in the enormous German investment in car manufacturing in places like Alabama and South Carolina. Government intervention in the economy always has unforeseen consequences and history shows us these are more often negative than positive.

The real problem facing American families is not the abstract notion of balance of payments. Rather the deficit is a symptom of America’s waning productivity. Even if the tariffs are successful (in that they turn people off buying foreign products) and the balance of trade swings back into the black, it is unlikely to change the economic reality, which is a lack of productive jobs in the economy.

Of course there is a contradiction here, with such an interventionist move being instigated by a Republican president, the long term party of free markets and invisible hands. Maybe it is a sign of the times, with the traditional right/left lines becoming blurred across the globe, from the UK and Mexico to China and Italy. However, regardless of politics, this does highlight an important question for us economic conservatives.

What do we do when the free market produces a result that we do not want?

Rather than look to resolve the symptoms of the problem we should remember to focus on the root cause. The situation facing Trump is not an enviable one, because unfortunately there is no pain-free cure for decades of economic mismanagement. The president, and folks of his generation, were raised to understand production was good, and that is certainly still true, if somewhat forgotten, today. Trump has put this back on the agenda again, after being marginalized for so long, and that is positive in its own right. However, there is another key feature and that is that a free market will dictate what production is best, without guidance from the government.

Liam P. Browne is an economist by education and a financial consultant by trade. He is a specialist in derivatives contracts, currently working in London and splitting his time between there and Mexico City. Liam studied in Newport, Rhode Island, as well as in Ireland and Belgium. He graduated cum laude from The Katholieke Universiteit Leuven in 2011 as a Master of Business Economics. He is a self-professed expert on all matters EU; especially how its workings impact financial markets and economies. Any questions or requests can be sent to @EUderiv on Twitter for an (unaffiliated) answer or discussion. To read more of his reports — Click Here Now.

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LiamPBrowne
What is a trade deficit and why should we care?
trade deficit, tariffs, trade war, trump, china, mexico
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2018-33-22
Wednesday, 22 August 2018 12:33 PM
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