Revisiting the Trade ‘Deficit’

If you enjoy reading about record highs and round numbers, the financial news world had a special present for you Tuesday: the revelation that the US trade deficit notched a new record high last year, with the deficit in goods trade topping $1 trillion. What better time, then, to revisit why the trade deficit is a meaningless number for the economy and stocks?

One of the longest-running economic misperceptions is that the trade deficit is, well, an actual deficit—a giant sucking sound signifying money draining out of the country. If the US imports more than it exports, the logic goes, the country will get steadily poorer as the rest of the world leeches American money and jobs. If we could just make more of what we buy, they say, the economy and society would be much, much better off. That is the theory.

In reality, the trade deficit is a negative in a mathematical sense only. When GDP counts trade, it counts net exports—exports minus imports, a practice designed to net out imports’ contribution to sales. This means statisticians treat the resulting number as a negative. But the logic operates on the presumption imports have no effect on US economic activity, which is rather ridiculous. When imports are high, it means consumer and business demand is strong. It means retailers, automakers and many more are probably doing quite well. It is also a good sign for the advanced American factories that import intermediate parts. This is why the trade deficit often widens during US economic expansions and narrows during recessions—the opposite of what you would expect if a big trade deficit were inherently problematic.

Strong demand—coupled with the pandemic’s lingering effects—explains 2021’s big deficit. As we and many others have documented, Americans’ demand for physical goods soared last year. That was a byproduct of services taking longer to reopen as the country emerged from the worst of the pandemic. When gyms stayed closed, people bought free weights and exercise bikes. When restaurants operated below capacity, folks upgraded their cookware and honed their culinary skills. And we all bought gadgets and gizmos galore as telecommuting tightened its hold. All told, imports of goods hit a record-high $2.85 trillion last year, almost $300 billion more than 2018’s prior high.^[i] That is a huge demand bump!

Meanwhile, as the pandemic continued blocking international travel, tourism stayed weak—bad for trade figures, since tourism is an export, registering primarily as a services export. Hence, services exports remained over $100 billion below pre-pandemic highs last year.^[ii] Yet goods exports hit a record-high $1.76 trillion, which was nearly $100 billion above the prior high.^[iii] Not too shabby.

As for the notion of trade deficits draining money from the US, reality disagrees. The money America spends on imports actually doesn’t go overseas—it stays right here, in the form of foreign investment. In our view, it is no coincidence—none whatsoever—that another big news item Tuesday was the record-high foreign investment in US commercial real estate last year. The Bureau of Economic Analysis hasn’t finished tabulating full-year investment data yet, but through Q3, inbound direct investment was up over $2.5 trillion from a year prior.^[iv] Now, part of this increase stemmed from rising asset values, but new flows also account for a big chunk of it. (Exactly how much, we will know when the statisticians finalize 2021’s balance-of-payments data.) Occasionally, high inbound investment gets a bad rap politically, but it expands this country’s productive capacity and helps make society better off overall. For a practical example, consider Samsung and Taiwan Semiconductor’s big American semiconductor foundry projects—inbound foreign investment in action.

Some argue the big trade deficit signals America is too reliant on overseas producers and too vulnerable to the present supply chain woes. If more production were here, they argue, then our economy would be roaring even more mightily. Which, maybe, but don’t ignore the counterfactual. We also happen to be smack in the middle of a labor shortage. Who is to say supply wouldn’t be worse if more of the supply chain was on our shores, due to understaffed factories? As for logistics, seaborne freight wouldn’t be an issue, but the shortage of truck chassis would still bite hard. Add in higher labor costs, and businesses’ gross margins might be stretched to the breaking point. We aren’t saying that is for sure how it would go, but it does seem like a realistic—and widely overlooked—possibility. There is a reason why globalization took root—it was efficient.

Playing the what-if game is always tempting, but it is an academic exercise. It has no bearing on the factors stocks care about—chiefly, expected corporate profitability over the next 3 – 30 months and the degree to which political and economic developments look likely to disrupt earnings growth. Anything beyond that is noise to markets—including the trade deficit. It is an accounting entry. Trivia. A logical consequence of an economy whose main engine is knowledge and services—the fruit of America’s long-term economic advancement. But that is the extent of its significance, in our view.