US President Donald Trump has declared that America's $500 billion trade deficit with China means that the US is "down" $500 billion. Apparently, he thinks that trade surpluses and deficits amount to profit and loss statements for countries. He could not be more wrong.
Let's say that a developer, erecting an apartment building in New York City, purchases $50 million worth of construction material from China, and spends another $50 million on local services. If the developer then sells the building to American buyers for $110 million, he has made a profit of $10 million.
The venture, it seems clear, made good business and economic sense. The $50 million spent on Chinese imports certainly would not be considered a "loss." Yet that is precisely what Trump's logic implies. Worse, Trump would demand that, to "even things out," China purchase $50 million of US products - or face tariffs that make it more expensive for future US developers to purchase construction materials from China.
If, for example, the new tariffs totaled 25% of the "loss," or $12.5 million, the same project's total cost would jump to $112.5 million. A $110 million sale would then imply a $2.5 million loss, rather than a $10 million profit. A smart developer would work this out in advance, and potentially scrap the project altogether (unless they could find local suppliers to offer a better deal). That would hurt the entire economy, especially if the tariffs affected a large number of investments, as Trump's steel and aluminum tariffs will.
For the sake of any who share Trump's flawed logic, the point can be clarified further. The $50 million the developer spent in China was exchanged for $50 million worth of goods. That makes it an equal and balanced transaction. Demanding that China purchase $50 million worth of US goods would have no impact; it would simply produce another equal and balanced transaction.
To use the language of deficits and surpluses that so trips up Trump, the US might have a "currency deficit" of $50 million following the developer's transaction, but it would also have a "goods surplus" worth $50 million. The fact that the US dollar is the main global reserve currency makes this all the more agreeable, because the developer was able to pay for those Chinese materials directly using dollars.
If the dollar were not the main global reserve currency, the US government would have more reason to be concerned about the currency deficit from trade, because the developer would then be forced to purchase $50 million worth of another currency - say, Japanese yen - in order to complete the transaction. This could raise fears that US reserves of yen would become depleted, and that purchasing more would devalue the US dollar. In that case, the US government might encourage more foreign purchases of US goods, in order to "balance" the currency deficit.
But that is not the situation Trump faces. Instead, the Chinese end up with $50 million in their bank account, in the form of US dollars that they can then use to purchase US government bonds, thereby financing the US budget deficit (as they have long been doing). They can also use those dollars to buy US stocks, helping US businesses and the overall economy, or to buy products from third countries, boosting global trade.
In an open economy, businesses are free to buy and sell products in whatever markets they can access. In our example, the Chinese neither forced nor duped the developer to purchase their construction material. Instead, a willing buyer chose to engage with a willing seller on the basis of a straightforward economic calculation. The developer most likely chose not to purchase the materials from US suppliers because the cost would have been higher, resulting in lower profits - or even a loss. If a government forces a business to make what is clearly an economically sub-optimal choice - say, by using tariffs - the rest of the economy will suffer.
So if the US runs an $800 billion annual trade deficit, it is simply because US businesses and consumers choose to purchase $800 billion more in goods from the world than the world has purchased from the US, owing to some advantage, such as lower prices than domestically produced equivalents. In the case of a business, this means a larger profit margin. In the case of consumers, it means more money to spend on other goods and services. Either way, the US economy benefits.
So does the global economy, because that $800 billion of surplus US currency can be used productively by the world to purchase financial or real assets. This does not hurt the US - a unique advantage enjoyed by the reserve currency-issuing country - and boosts global economic dynamism and growth.
From a policy perspective, all the US should be concerned about is ensuring that inflation does not creep in, owing to an excessive supply of US currency. That is not up to the Trump administration, but to the US Federal Reserve, which has a strong record on this front: despite a $14 trillion aggregate currency deficit on trade since 1990, the Fed has managed to keep inflation low.
As for Trump - or at least his advisers - the need for a better understanding of how global trade actually works has become glaringly obvious. Barring that, his administration's reckless interventions are likely to continue, or even escalate, causing severe damage to the US and the global economy.
Asad Jamal is the founder and chairman of ePlanet Capital.
Copyright: Project Syndicate, 2018.
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