News broke today that the U.S. trade deficit on goods and services rose to a 9.5-year high in February. This is exactly the same news as that headline, that the surplus on the capital side of the account was at a 9.5-year high in that same month. That balance of payments always balances, and that means that a deficit on the current account is always exactly equal to and offset by a surplus on the capital account.
That means that exactly as we buy more things and because we buy more things from foreigners than they buy from us, then they must be — there is no argument about this, it is a definition — sending us their money to invest in America. They might buy government bonds (Uncle Sam then gets to spend the money), they might buy stocks, they could invest in a new company, build a factory, buy a house, but that capital comes into the U.S. and we get to use it to make us richer, because that’s what using capital does.
This all seems pretty good to me. America gets to use foreign money to make America richer. That’s not how everyone else sees it, of course. Take Reuters: “News of the worsening trade deficit…” Well, foreigners are investing more in the U.S., why is that worse? Or look at the Dow Jones: “The U.S. trade deficit rose 1.6% in February to reach nearly a 10-year high” — no one at all is pointing out the other part of the statement, that foreigners are, and must be, investing more in the U.S.
Do note that to economists it is the investment part which drives the trade deficit, not the other way around. If America invests in itself more than it saves, then there will be a trade deficit, whatever anyone does about tariffs or shouts at the Chinese. If America saves more than it invests, meaning U.S. investment goes to foreign countries, then there will be a trade surplus. That’s just the way it all operates: The capital account drives the current account.
Some do manage to get this, as with Warren Buffett and his story of Squanderville and Thriftville. What happens when we’ve sold all of America to foreigners and all our profits flow to them, not to any of us? The answer here is that the problem, the trade deficit/capital surplus, just isn’t large enough to matter. The household wealth of the U.S. is around $96 trillion (it doubles again if we add in the government and all the land and assets they own). This also rises by, in recent times, perhaps $2 trillion a quarter. So, if we’re not creating any more wealth, we can finance the trade deficit for nearly two centuries. But we are creating more wealth, and we’re doing so faster than foreigners are buying it. In fact, we’re creating $8 trillion more wealth each year, and foreigners are buying about half a trillion of it each year. We can finance the trade deficit forever. In fact, even as we finance that deficit using the capital surplus, foreigners end up owning an ever smaller percentage of U.S. wealth. We’re creating it 16 times faster than they can buy it.
The trade deficit really just totally doesn’t matter. We can do this forever and we’ll continue to get ever richer as we do. The reason being that the balance of payments really, truly, does balance, and if we have a trade deficit with foreigners, then those very same foreigners must be sending their money to invest in America. No ifs, buts, or maybes — they must. And ain’t it great to be getting richer on other peoples’ money?
Tim Worstall (@worstall) is a contributor to the Washington Examiner’s Beltway Confidential blog. He is a senior fellow at the Adam Smith Institute. You can read all his pieces at The Continental Telegraph.
