For Every Trade Deficit, a Surplus

Here is a sentence you may have seen, in some form, throughout the coverage of the Trump administration’s tariffs: When the current account is negative, the capital account is positive, making tariffs pointless. The trade deficit makes up the bulk of the current account, while financial flows are the bulk of the capital account. So this statement means that if a country imports more goods and services than it exports, more money flows in than out, making it silly to use tariffs to reduce the trade deficit. And more importantly for our purposes, it illustrates one reason why US stocks endured a tariff shock. 

To those who know the nuances of trade and capital flows and “balance of payments” national accounting, it is an easy concept. But that doesn’t really include most people. In our experience, most people like data to back up such general statements. So here is a picture with some data. This is the US’s annual current account balance (again, mostly—and sometimes entirely—the trade balance) and net financial inflows since data begin in 1960. As you will see, they are just about mirror images of each other.

Exhibit 1: Trade Accounting Identities, Illustrated

Source: FactSet, as of 5/21/2025. Annual current account balance and net financial inflows (inflows minus outflows), 1960 – 2024.

We (and many others) have written before that these items must balance. So you may wonder why they are not a perfect offset. There are a few reasons for this. One, the general statistical discrepancies you get from differing accounting methods and exchange rate fluctuations, which the Census Bureau helpfully includes in a line item called “Statistical Discrepancy.” Financial derivatives also add some skew, as can reserve asset activity. Nothing major, nothing disrupting the overall mirror image, just the side effects of having a really, really, really big US economy.

In this context, we think tariffs’ folly becomes clearer. Aiming for a reduced trade deficit means aiming for fewer financial inflows … and more outflows. Some politicians say a lower trade deficit is good because it means more things are being made here, which means more jobs. Perhaps, but the counterargument is that a lot of the foreign capital inflows also support jobs. Using tariffs and industrial policy to reduce the trade deficit may change the composition and location of some jobs, but is that a net benefit? Who is to say? (And that is a may, as many firms relocate production for reasons that will prevent them from shifting back, tariffs or no.)

We aren’t writing any of this to make political points. We are always agnostic on such things, and we would write this regardless of which party or people were pushing tariffs. It is important, because these questions contribute to the uncertainty markets have been dealing with since Liberation Day. Whether tariffs, taxes, regulations or what have you, markets get nervous when policy changes create winners and losers. The relationship between trade and investment flows shows you tariffs would likely do exactly that, to varying degrees. Which means stocks have had to think through the implications in a hurry and constantly re-evaluate the landscape as the administration has changed tack on the fly.

We still don’t believe this is outright bearish. Policy changes that create winners and losers aren’t positive for stocks, in our opinion, but not every negative causes a bear market. Stocks priced the worst-case scenario of full tariff payments in a hurry in early April. Since then, they have been discounting policy changes, lower-than-expected customs revenues, anecdotes of businesses adapting, businesses’ tariff plan announcements and more. It is a lot to sift through, and the overall uncertainty hits the US harder than trading partners—which is a big reason why European and Asian markets continue beating US, in our view. But US stocks have come a long way from the lows, which shows their ability to adapt and adjust.

Maybe it is our free-market bias, or maybe it is our deep studies of financial history and market behavior, but we think stocks do best when the market is allowed to move goods, services and capital freely around the world, all going to their best, most productive use. Attempts to direct traffic, whether through tariffs, capital controls or industrial policy, generally cause headaches and reduce risk-taking. But for better or worse, truly free markets are more of an ideal than a reality, and governments have always monkeyed around. So stocks have never had—and don’t need—perfect. Which means trade policy now needn’t be perfect, great or even necessarily good for markets to do fine overall. If tariffs’ bark remains greater than their bite, as we think is the case, that should suffice.