A Reverse Perspective on Trade and Tariffs

It isn’t every day that a nerdy gal like me relates to a jetset racecar driver, but IndyCar star Pato O’Ward was a man of the people this week. With Tuesday’s Indy 500 practice paused for a rain delay, the big story was … wait for it … his sitting on hold with an international shipping carrier for an hour on live TV trying to pay an unexpected customs bill on his race helmets, newly subject to US tariffs. It is a headache many folks and I have had this spring, contributing to broad economic uncertainty and risk aversion, all because US politicians wrongly see the trade deficit as a problem. Here is the funny thing: Those nations with big trade surpluses? They envy trade-deficit nations. Whatever side a country is on, the grass seems always greener on the other.

Consider China, which has purportedly eaten the US’s lunch while cleaning its clock since joining the World Trade Organization in 2001. Its trade surplus in 2024 was nearly $1 trillion, which by more than a few US politicians’ logic, should make it a pillar of economic strength and hoarder of capital siphoned from the US.^[i]

But consider it from China’s perspective, and you will see radically different viewpoints. There, the trade surplus represents not industrial might, but industrial overcapacity, fueled by decades of misdirected investment. Economists see an over-reliance on external demand because consumers don’t have enough firepower to buy what local factories produce. They see a government trying to preserve fast economic growth by funneling capital to heavy industry to spur exports instead of fostering sufficient development in domestic services and consumption. Adding to pain, they see an artificially weak currency, aimed at making exports more competitive overseas, that makes life more expensive for domestic folks. To them, an economy that produces more than it consumes is a burden, not a blessing. There is a reason China’s government spent much of the 2010s shuttering blast furnaces to curb steel production.^[ii]

China’s big trade surplus brings another particularly annoying side effect: capital controls. Money can’t flow freely in or out. And the trade surplus is a big reason why. One, a managed currency is incompatible with free-moving capital. And two, always and everywhere, a trade surplus is a financial account deficit. Meaning, when you have more goods flowing out of your country than are flowing in, it means you also have more money flowing out of your country than flows in. Because China’s trade flows hemorrhage money out naturally, the government micromanages the capital account.

Here is why. When a Chinese business exports goods to the US, Americans pay for those goods in dollars. The Chinese business has three options. 1) It can use those surplus dollars to buy American goods. 2) It can invest those dollars here. 3) It can trade those dollars for Chinese yuan, effectively selling them to someone else who will invest or spend them here. There is not one single scenario where the export revenue enters China as new capital to fund local growth. It all pours into US assets—stocks, bonds, facilities, you name it. The world invests here because it sells here.

In technical terms, this is called an accounting identity. And in practice it always means that when a country’s imports exceed its exports by a given amount, its foreign capital inflows exceed outflows by that same amount (or very close to it, given accounting differences and exchange rate fluctuations). Which means that while America gripes about China’s trade surplus, China gripes about America’s investment surplus. Each seems to want what the other has.

This is an unseen reason why tariffs won’t boost US manufacturing. The goal seems to be for non-US companies to make products for the US market within the US. But when you tax the bejesus out of imports, you get fewer imports, which means you also get less foreign capital coming in. This math hampers international firms from investing in new facilities here. And if America starts running a big trade surplus (unlikely!), then it means a mass exodus of international capital. The realignment probably leads to a lot of things we as a country don’t want, like falling stock prices, jumping bond rates and the closure of international firms’ US-based facilities.

To international observers, this looks self-destructive and pointless. With very few exceptions, like mercantilist Germany, as countries move further up the development curve, they evolve from trade surpluses to trade deficits. It runs parallel to economies developing from agrarian to manufacturing to services to whatever comes next (space services?). And it generally comes with longer life expectancy (as workplaces get safer), higher per-capita income (as industries become more productive) and much less pollution. This is why development is a universal goal.

This is an abstract concept, so let me show you with my own family history. Maybe yours is similar. My grandmother grew up poor in Rockingham, North Carolina in the 1930s, on the young end of a family with eight surviving children. She did all the cooking and housework from a young age because her parents and her older brothers did backbreaking work at the mill. And when they weren’t at the mill, they were toiling to eke sufficient food out of their small farm. My grandpa grew up a few miles away, in Chester County, South Carolina, the family scraping what they could out of a poor tenant farm. They eloped when my grandma was 16 and my grandpa was off to North Carolina State on the GI Bill, the first in his family to go to college. Having discovered a knack for gadgetry while serving in the Pacific, he studied engineering and eventually became a contractor for NASA, helping design the telemetry systems for the Gemini and Apollo programs. They lived a comfortable suburban life outside Houston, with living standards light years away from what they grew up with, and their four children all worked in medical or financial services. That is America’s development arc in one family.

Mercantilism stalls this arc, whether it is China’s imbalances or Germany’s overreliance on heavy industry, which has basically caused a two-year recession there. There are many in China who covet what America has: a thriving, services-based economy that doesn’t require heavy pollution and sometimes-sketchy working conditions to generate widespread growth. All Europe envied Germany’s trade surplus, but now neighbors are relieved their services-rich economies are growing as Germany’s stalls. Yet, oddly, they continue complaining about their own “de-industrialization” instead of appreciating it as development.

I have this pet theory that societies can never be happy with their economic model, all tying back to the innate human condition and engrained tendencies toward envy and covetousness. People in communist nations always envy more capitalist outposts, wishing they had genuine choice and abundance. Capitalist nations always have strong socialist and communist movements. Those living under mercantilism want freer trade to diversify their economies. Those with free trade decry its perceived drawbacks. We humans are just inherent malcontents, whether you choose to blame original sin or evolution, hard-wired to hate what we see as loss much more than we appreciate what we count as gain.

And so we get politicians promising salvation, then implementing policies that do more harm than good. I am not talking about one person here—I am talking about the vast majority of politicians in world history. Instead of having the humility to get out of the way and let businesses and people do their thing, they swing big hammers in search of nails. China’s trade surplus has grown by about $700 billion since 2007, but its stock market is basically flat since then, down a bit in price-only terms and up a bit with dividends.^[iii] The US trade deficit has grown about $400 billion during this span, and the S&P 500 is up about 300% in price terms and 450% with dividends.^[iv]

Take your pick, but to me, the stock market is telling us tariffs are a bigger problem than the trade deficit. Or rather, maybe markets are screaming it from the rafters! Mercifully, stocks have probably priced in most of the damage to a great degree this time, but opportunities—and returns—are clearly higher outside the US these days, in my view.