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The good news behind the June trade deficit

The trade deficit increased in June because the growth rate of exports has slowed. The market is interpreting that to be bad news, but it isn't.

To begin with, there's nothing wrong with a trade deficit. In fact, many healthy economies have trade deficits. A trade deficit is the flip side of a capital inflow—you can't have one without the other—and capital inflows are a measure of foreign investor's confidence in your economy.

Treasury is selling over $100 billion a month of T-bills and T-bonds, and foreigners are buying a good portion of that debt. That leaves foreigners with less money to spend on our exports. Our export growth has declined, but our sales of T-bonds to foreigners have risen. Since nobody is holding a gun to foreigners' heads and demanding that they purchase our debt (and low interest rates suggest they are quite happy to do so), one is forced to concede that foreigners have made a decision (to buy our bonds instead of our debt) that is in their best interest. If they didn't feel good about doing that, they could shun our debt, which might make interest rates rise, but they would be left with more cash to buy our exports.

The only bad thing about our trade deficit is that it's likely driven at least in part by our federal government's voracious need to finance its spending habits, which in turn means that we are likely squandering some of our capital inflows since they could be put to better use if they were available to the private sector rather than being gobbled up and spit out as transfer payments.

Meanwhile, the very strong growth in imports, which has been running at a 20+% pace for the past nine months, is a excellent sign that U.S. consumers are feeling much better about spending money (incomes are up, confidence is slowly returning, money hidden under mattresses is being spent), and that is unequivocally a good thing.

This last chart compares imports and exports to consumption. What it shows is that imports have represented about about 20-25% of our total consumption expenditures for the past decade or so—imports on average have grown at about the same pace as consumption. Meanwhile, our exports have grown faster than consumption, and exports are now only a shade below their all-time high relative to consumption. This means that our exports are financing a greater share of our consumption than at almost any time in history, and that represents a healthy diversification for our economy.

Another observation: the U.S. economy is now more than twice as integrated into the global economy than it was back in 1980, because our imports and exports have more than doubled in size relative to consumption. It's hard to see how this could be a bad thing.

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