Are Trade Deficits Bad for the US? It’s Complicated

Steve Odland: Welcome to C-Suite Perspectives, a signature series by The Conference Board. I'm Steve Odland from The Conference Board and the host of this podcast series, and in today's discussion, we're going to talk about trade deficits. What are they? Why are we paying attention to them all of a sudden? And where are we going?  

Joining me today is Maria Demertzis, the Economy, Strategy & Finance Center leader in Europe at The Conference Board. Maria, welcome.  

Maria Demertzis: Thank you, Steve. Great to be here.  

Steve Odland:So Maria, I'm sure our listeners have heard trade deficits in every media that they consume, but let's just start with the basics. What is a trade deficit, and how do they measure them?  

Maria Demertzis: A trade deficit is, I should say a trade balance, it is the difference between the amount of goods and services that the country exports versus the amounts of goods and services that the country imports. That's the trade balance. And if exports, the value of exports, is bigger than the value of inputs, then the trade balance is in deficit. And if the other way is true, if the exports are bigger than the imports, then we have what we call a trade surplus.  

Steve Odland: And so how is this measured? The governments measure these things, is there somebody at the border with an abacus doing this? How do they literally do this?  

Maria Demertzis: The technological advancement of an abacus is probably the right way of describing. Yes, of course. I think we mustn't underestimate the technology and the meticulousness with which we measure these things. National accounts, of which trade balances are a part, are captured by the data that comes into the ports. These are the entry points and, of course, the exit points for our exports, and all of them are being collected.  

Typically, and now I'm speaking for Europe, these are collected by the central banks, or the balance of payments data. They're the ones who are collecting this, and there are very very tight rules in ways that we are collecting this. And effectively, what we are measuring in dollar terms or in Euro terms or any other currency, depending on which country you live, they measure the value of the exports versus the value of the inputs, and there will be a corresponding payment that needs to be made. And that difference in the value will be either a trade deficit or a trade surplus. 

Steve Odland: And is this done at the country level or the trading bloc level?  

Maria Demertzis:So I suppose for the US, it is at the country level, but also for the EU, which is a trading bloc, it is done at both levels. So it is collected at the country level, and it is aggregated also at the EU level, which is the trading bloc level. 

Steve Odland:So is the issue then country to country? So in other words, if the US is running a trade deficit with Germany, is that the issue, or an issue? Or is the issue really versus the US versus the EU? Just to use an example.  

Maria Demertzis: Things get a little bit more complicated here. It really is both of what you described. There will be a trade balance position of the US with Germany and with France and with Italy. But there will also be a trade balance position vis-a-vis the whole of the EU. So we will have both numbers, and one is an aggregate of the other.  

Steve Odland: And which is relevant? Are both relevant, both the country level and the trading bloc level, or is one more relevant than the other?  

Maria Demertzis: It depends what the underlying story is here. It could very well be that the US runs a trade deficit with one country, let's call it Germany. And that is true, there is a trade deficit, but it runs trade surpluses with other countries. 

Now, I don't actually have the data in my head. Collectively, the US has a trade deficit with EU. Collectively. But that does not necessarily mean that it has a trade deficit with every single country. It's just that when you aggregate it up, it could be a deficit, it could be a surplus. 

Steve Odland: And so it depends on, they're both relevant to some extent. But because the EU negotiates trade as a bloc, it really is the bloc level that is the most relevant.  

Maria Demertzis: I think that's right. It's a fair assessment. The trade policy is unique in the EU, as you described, and therefore, to the extent that you care about how the policies may be affecting or not affecting trade balances, then of course, it will be the bloc decision that matters, yes. That's a fair description.  

Steve Odland: So why does the trade balance between nations or trading partners, why does this matter?  

Maria Demertzis: OK. That is actually a very good question. And it is, and to an extent the answer is, and I think that's what you're driving at, but please correct me if I'm wrong, I think you're driving as to whether deficits are bad and services are good. Is that necessarily the case? And I think the answer to that is not necessarily, it really depends.  

Solet's go back and look at what is a trade deficit. And when does a country have a trade deficit? So if I may start from the very beginning. There is an issue of trade specialization. So think about German cars versus digital services. There is an issue of specialization. Germany tends to produce good cars that the world wants to buy, and then the US tends to produce good services or digital services. You think of the big gaffers, you think of Netflix. These are all US services, right? And it is the case that there is a specialization. One does services better, and the other one does cars better. So the fact that the two blocs trade, and again, at this point I'm talking about Germany versus the US, both benefit. They benefit from the fact that they have better products because they happen to have a specialization of one product. So the bilateral trade position doesn't really matter.  

But if you have one country that has gotglobally a trade deficit position, then what this means is that this country imports a lot more than it exports. That's what a trade deficit means. So the question that arises after that is, can this country afford to pay for these imports. And this is, I think, the interesting part, at least in economic terms. Can the country afford to buy so many imports and therefore have a trade deficit? And the answer to that question varies from country to country. 

If you're a small country that aims to buy goods from abroad, you are typically going to have to pay in the currency of the bloc from which you're buying. If you don't have the means to do that, you will not be able to buy that. Or if you run a very large deficit, there will be pressure on your currency to depreciate. 

So is that the story of the United States? Because the United States have had deficits for a very long time and more or less globally, right? Because the trade balance in the US has been in a deficit position globally, meaning with all countries, for a very long time. But have we seen pressures on the dollar to depreciate as a result of having a trade deficit? And the answer is no, But why is that?  

And here comes and this is an important difference, which makes I think the US unique, and that is the dollar. The countries that trade with the US, and not just the countries that trade, everybody's interested in having the dollar. That means that the US can afford to run trade deficits because it can borrow globally at very low prices. Why is that? Because people want to hold dollars. That's what we mean when we say that the US has an exorbitant privilege. The privilege of everybody in the world wanting to hold the US currency, which effectively allows the US to try to run trade deficits for a long time without necessarily that putting pressure on the economy and on the currency to devalue. 

So if you think about that, the US has had the ability to consume as a result of the fact of having the currency that everybody wants to buy, which is the dollar. So the US welfare has been sustained at very high levels as a result of that.  

Steve Odland: So let me see if I understood you correctly. So the US is largely running trade deficits with most of the other large countries and trading blocs, which means that the US imports more than it exports in trade to those blocs. As a result, that means that as they import more, they're paying for it with dollars. There are more dollars going, in this case, to the EU or to China, than there are currencies coming the other way. 

And normally that would put pressure, downward pressure on the US dollar, in this case, because people want to hold, countries want to hold that as a reserve currency. That pressure hasn't happened in the same way. Conversely, the benefit of this has been the US consumer, who has benefited from lower-cost goods and services coming into the country than presumably they would if they were all forced to be produced and consumed domestically. 

Is that roughly correct?  

Maria Demertzis: Exactly. Or if the dollar was not as a popular currency as it is now. So effectively, the US is a net borrower, whereas countries that have surpluses, meaning the EU and China, they are net lenders. They're the ones who lent money. But the US has afforded to be a net borrower for a very long time because of the dollar. And indeed that has helped US consumption.  

Steve Odland:So this is off the subject to some extent, but then the question is, why is the dollar valued so much?  

Maria Demertzis: Exactly. Exactly. This is not off-subject, actually, if I may say, Steve, I think it'sactually essential to understand that privilege. 

I will say in a minute that actually, the privilege comes also with responsibilities, but I will explain that in a minute. It is actually the currency of last resort, if I may call it this. Two random countries in the world, let's say Chile and India, want to trade. They can price in whichever currency they like, but they typically trade, when they exchange money, they trade in dollars. That's what means that the dollar is the international currency. And the US benefits from it because then it has more dollars that are circulating in the world and therefore pays very little to borrow from the world. That'sthe exorbitant privilege.  

But why is the dollar so popular? And in my view, it's two things. The first one is the dollar is a good currency. It's a stable currency, it's a predictable currency, and therefore it's a unit of transaction, which is what you need when you trade. It is very reliable, meaning that I know when I say $1, I actually mean $1. I know what it means in value. That's the stability of the currency. And it has to do with institutions. It has to do with the Fed, it has to do with the economy, and it has to do with the law. People trust that the dollar will be honored. It's an economy and a society that functions, and that's what gives the dollar its demand. 

The second one has to do with settlements, and we must not underestimate the value of settlement. Meaning that, when these two countries trade with each other for this transaction to be, if you like, legitimate, it needs to be settled. And if it's done in dollars, then it will be settled by US authorities. If it is done in Euros, it will settle by EU authorities, and it will be sealed as a legitimate transaction. There isn't an infrastructure across the world between countries to allow for this settlement to happen. That's why many countries in the world, in my example, Chile and India, it's the second reason why they like the dollar, because there is a settlement infrastructure. 

So two reasons: good currency, and it provides the settlement infrastructure.  

Steve Odland:Yeah. So that's supply and demand. There's also, you have to think about the supply aspects of it, too. And part of the issue is the money supply, and the US Fed continuing to, to print the currency and create more money. 

Maria Demertzis:That's right.  

Steve Odland: And jeopardizes potentially, depending on, there needs to be expansion for the size of the economies, but it does jeopardize, potentially, the value of the currency, as well.  

Maria Demertzis:SoI think that comes now with, if I may call this sort of the flip side of this exorbitant privilege. As you say, typically if you print money that will be inflationary, right? So the US prints money, but we don't see the inflationary impact coming from this plenty of money. What the Fed does is it provides liquidity across the global markets to sustain operations. And in fact, typically, you see this very much in during crisis. We had this in the financial crisis, we had this in the pandemic crisis, where the Fed extended what we call liquidity lines, effectively helping banks across the world meeting their obligations without that printing of money affecting the US economy.  

This is, if you like, the obligation that comes with the exorbitant privilege, if you are the currency of last resort, to facilitate global operations on the financial side. Yeah, so that's really, if you like, the obligation that of course the US does provide, almost as a public good to the world, for the privilege that it has of borrowing very cheaply globally.  

But of course, the US can decide not to do this anymore, not to provide this liquidity for whatever reason. And that, of course, will damage international financial flows and, at the end of the day, will also damage the US because if the global market doesn't work, nobody benefits from it. But at the moment, it is the goodwill of the US to provide that.  

On the other hand, it does raise also vulnerability for the US, and I think that needs to be acknowledged. And that is exactly the fact that this exorbitant privilege is because countries really want the dollar. If from one day to the other, the world wakes up and says, "You know what? I don't want the dollar, I don't want the settlement infrastructure of the dollar. I can do something else," that, of course, will reduce the demand for the dollar and it will also reduce the ability of the US to borrow so cheaply and therefore also the ability to sustain imports for so long. So it will correct the current account deficit, but it will automatically also reduce the welfare position of the US. 

Steve Odland: With privilege comes responsibility, essentially. And that's the crux of the role of the independent US Fed. We're talking about trade balances, deficits, and surpluses. We're going to take a short break and be right back.  

Welcome back to C-Suite Perspectives. I'm your host, Steve Odland, from The Conference Board, and I'm joined today by Maria Demertzis, the Economy, Strategy & Finance Center leader of The Conference Board in Europe. 

So Maria, before the break, we were talking about trade balances, the currency, and so forth. Some of the politicians in the US and elsewhere have said that by running a trade imbalance with another country, that some countries are simply stealing the wealth of another country. 

Why do they describe it that way? And is that fair?  

Maria Demertzis: As we were saying earlier on, if you have a persistent trade deficit without facing the risk of a currency devaluation, like the US is, then the US benefits from it, provided it can sustain it, of course. But I want to talk about that stealing of wealth the other way around. 

Think of sustained surpluses. And Europe is one of them. Sustained surpluses means that money from the EU leaves the EU and gets spent elsewhere. Typically, it is investors. And if you have sustained surpluses and you have huge domestic investment needs, then you have to ask the question, is this good for your bloc? And I'm saying this because this is exactly the position where the EU finds itself. We have in the EU, on average per year, about 400 billion euros that are leaving the EU, and they're invested in other jurisdictions outside EU, when at the same time we have about a trillion of investment needs. 

What does this mean? It means that private money firms, European firms, do not think that their investments will have a return that is worthwhile in the EU, and they go elsewhere. In fact, where do they go? They go to the US, and they go to China. So when you say stealing the wealth of nations, what do you actually mean? 

Because the opportunity cost, seen from a surplus jurisdiction, the opportunity cost of trade surpluses is enormous. This is actually the soul-searching that is happening on right now in the EU is about that. How are we going to get European money, and indeed, anybody else's money if they wanted, to come back to Europe and help us cover the investment needs that we have? 

So I think this discussion on stealing wealth is misplaced. If you are a country that runs deficits which are sustained, there will be market pressures to devalue. If you have afforded to run trade deficits without seeing the pressures on the currency, it means you have an exorbitant privilege. And I think this is where the US is. Now that said, you have to also ask the question, "But could it be that trade deficit and trade services are manipulated?" I think that's an important question to ask. They could be manipulated, and I think we're going to get to that.  

Steve Odland:Yeah. But I think your point is that you can't just say, it's stealing the wealth. That's a political statement. It's not an economic statement.  

Maria Demertzis: Exactly.  

Steve Odland: And it's not necessarily true if the currency is also being, I don't want to say overvalued, but highly valued beyond where it would be. So there are benefits that come with it. It shouldn't be thought of as the wealth of a country. 

And I think that's a really important point because, and this is why we went off and did our tangent on the currency, because you can't just think of the trade balance in a vacuum. You have to think about the currency impacts of that. And so therefore, the wealth concept is nullified by that. 

But one thing that does happen in countries that run surpluses is that it, particularly if it's goods, but also a little less so with services, is that you do provide jobs, domestic jobs in that country that are good. And in a lot of cases, these are manufacturing or mining jobs. So talk about the characteristics of countries that have trade surpluses with other countries.  

Maria Demertzis:It's not predetermined, in the sense that, if you go around and look at countries that have got surpluses, the first thing that one can say is that, of course, if you have natural resources, you're a lot more likely to have surpluses.  

Think about countries like Venezuela. Yeah, think of countries like the Arabian Peninsula, which have become oil producers, effectively. Think of countries like Norway. It no longer has natural resources cause they're exhausted, but it has actually accumulated a sovereign fund that was built on the back of the revenues coming from oil. And, of course, it allows you to invest it in a very responsible and sustainable fashion, and therefore it can afford to run trade surpluses. So for a moment, there's nothing to do with the economic buildup, of the fiber of the economy.  

Then you have countries that are big manufacturers, like Germany, that has a surplus, but then you have big manufacturers that do not have surpluses. I'm thinking of Italy. Italy is a big manufacturer. We tend to forget that Italy is actually a big manufacturing country, but it doesn't have a surplus.  

And then you have countries that have surpluses without being manufacturing, and I'm thinking of the Netherlands or Denmark. Much smaller countries. They have big services. These are big service economies, both the Netherlands and Denmark have got big surpluses and sustained surpluses, and they are all done on the back of the service economy, not on the back of manufacturing.  

Soit's not predetermined that if you are a big manufacturing country, you will necessarily run surpluses and the other way around. I think you're right in saying that manufacturing created jobs, but I think economic activity is not just about manufacturing. And like I said, Denmark and Holland, the Netherlands, are two countries that have gotvery low unemployment rates, very huge surpluses, and sustained over time, and they're, for all intents and purposes, service economies, primarily. 

Steve Odland:So in some cases, you're saying that yeah, there is some accident to geography. We think of the oil-producing countries in the Middle East and previously Norway, but not all. And so therefore it comes down also to economic policy from those countries or regions because you can create surpluses, you can create value, if you will, through other means other than strict natural resources. And services are an example of that. Is that a fair summary?  

Maria Demertzis:Yeah, exactly. But you can also have, and let's talk about the elephant in the room, which is China. China does not have natural resources. It has had a policy of huge manufacturing, "we wanted to become the manufacturing, the factory of the world." And the policies to get there, and here, I think you will agree with me. Certainly you and the US agree on this. There has been policies of actually controlling prices in order to create competitive products on the price side. 

And in the early 2000s, when China joined the international system, there was for a very long time talk about price manipulation, meaning you're keeping the price of goods low, and you can do it either by keeping prices low or by keeping the currency low. And you will remember the debates back then of manipulation, if you like, manipulation of your competitive position, right? 

If the value of your goods are, let's say a hundred, the fact that you're keeping either prices or exchange very low makes it much more competitive in the global market, and therefore it allows China to capture market shares. Yeah, this has always been the grievance that both the EU and the US had with China.  

But I think it's also fair to say that China has moved away from this for a number of reasons, including becoming a manufacturing jurisdiction in its own right, given the research and development investments that they have made. But at the beginning, meaning at the early entry of China in the global markets, it was very much a discussion about manipulation of prices and manipulation of exchange rates. 

Steve Odland: And this was the purpose of the WTO, the World Trade Organization, is to create a level playing field with rules by which all countries would operate. And therefore you wouldn't have these sort of imbalances, if you will, dumping ofgoods, that are in excess and so forth. But it's not a perfect world, even if you're a WTO member, and hence some of the grievances.  

Maria Demertzis:So if I may, thank you for bringing this up because I think it's so crucial to talk about, effectively, the global rule book. Because that's what the WTO is. It is a global rule book. When we talk about engaging in trade with each other or in these investments, we need to have certain types of rules that we can follow so that we can resolve disputes. That's effectively what makes a system function. 

A system can only be as strong as the rule book in which it operates, and here comes the problem with China, because it's interesting to see that the number of disputes that have been brought against China in the WTO is not necessarily bigger than the disputes against other countries. Certainly per capita, if you like, or per trade, per unit of trade. 

So that's interesting, which means that the China hasn't really violated the rule book more than others have. That is very interesting because that's not how we tend to think about it. But I think the issue, and that is an important grievance.  

Steve Odland: But when you say that,you're saying in aggregate, It may be that between one country and China, it may be imbalanced, but you're just saying in aggregate. 

Maria Demertzis: Yes, that's what I had in mind. I haven't really checked the numbers on bilateral disputes, but global trade, China isn't necessarily a bigger violator than other countries are. But that's not necessarily the whole story. And here comes the "Who wrote the rule book?" There is the law that we follow, but there's also the spirit of the law. And this is where disagreement happens.  

 I would say WTO is written by the US and Europe, effectively, and it is under the understanding that we follow certain rules in the way that we allow for our companies to be competitive. So that we don't really sponsor our companies to become competitive in order to have a level playing field. China has followed a completely different business model, and that is a business model where we finance, we provide subsidies to our companies in order to become big. And certainly for particular sectors. Think of manufacturing, think of chips, think of electric batteries. 

The dispute that we have is that while China is following the rule book of the WTO, it isn't necessarily following the spirit of the law. And therefore, there's a clash of business models between, if I may call it, the Western side and the Chinese way of doing business. This is the issue. The WTO book is not written for partners that do not follow the same business model. So the question is, we need a new book, and who's going to write that book, and who's going to hold the pen?  

This is, of course, for the future. I think that's really the problem.  

Steve Odland: And this is where all the WTO members need to get together and come to some level of consensus.  

You made the comment that China does not have natural resources, but you could think about it, they do have rare earth minerals, which is a natural resource, but you could think about their natural resources being their excess labor. And therefore, their inexpensive labor, and hence their ability to become the manufacturing center and then ship that stuff all over the world. And then, so you are incurring massive shipping costs, but it's still less expensive than to produce in some of these more developed nations, where the cost of labor is quite high. So you could consider that a natural resource.  

Maria Demertzis: Yeah, I put this under the business model, but effectively, we are saying the same thing. And remember there's the other big issue with China is respect for human rights. And that is, if you're not going to respect human rights and therefore capitalize on that, keep costs low, as you say, then of course, you can build up bigger manufacturing. But if you were to follow equal rules when it comes to human rights, then of course, the cost will increase. And that is part of the current grievances that we have with China, indeed.  

Steve Odland:Yeah. So we tried to simplify it to some extent. These are complex things because there are so many variables between countries, between trading blocs, and multiple ways to think about it. 

Maria Demertzis, thanks for being with us today and helping us understand trade surpluses, trade deficits, and trade balances.  

Maria Demertzis: Thank you, Steve. Thanks for having me.  

Steve Odland: And thanks to all of you for listening to C-Suite Perspectives. I'm Steve Odland, and this series has been brought to you by The Conference Board.