Trade Deficits

Where there is trade, there is exchange. The seller gives something up in exchange for something else. From this simple truth, we can see that there can never be a deficit. No-one is giving up something for nothing. Yet, we hear people talk about trade deficits all the time. China is supposedly running a surplus relative to the US. How can that be?

In the case of China and the US, we see that products are brought to the US from China, while dollars and dollar denominated assets are sent to China. The trade deficit is in other words about the type of things being sold. The deficit is not about an imbalance in trade, but an imbalance in production. China exports primarily goods while the US exports primarily services and dollar assets.

One of the reasons why this is the case is that the US holds the reserve currency. The dollar is an asset required for trade, and the only way to get fresh dollars is by sending goods to the US in exchange for dollars. The much talked about trade deficit is in other words a feature of the monetary system. As long as the US holds the reserve currency, it must run trade deficits. There is no other way for the system to be kept alive.

Slamming tariffs on imported goods will do nothing to change this. It will only make it more difficult for foreigners to get hold of dollars. This will in turn make it desirable for foreigners to find alternatives to the dollar when trading with each other. They will seek trading agreements that omit the dollar. China and Russia use currency swaps and gold in trade with each other, and many other countries are seeking similar solutions.

As more and more trade omit the dollar, the need to sell products to the US in exchange for dollars becomes less urgent. Should the world go away from the dollar all together, the dollar will cease to be the reserve currency. No-one will any longer need to sell goods for the sole purpose of getting dollars to trade with others. People will demand something else in return. They will demand goods and services. The US will have to restore their production base.

A balanced global production capacity will only come into effect once the US dollar stops being the reserve currency. Until then, the US will continue to sell dollars in exchange for goods from abroad.

Federal reserve note

By National Museum of American History - Image by Godot13, Public Domain, Link