By Asad Jamal/San Jose, California
US President Donald Trump has declared that America’s $500bn trade deficit with China means that the US is “down” $500bn. 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 $50mn worth of construction material from China, and spends another $50mn on local services. If the developer then sells the building to American buyers for $110mn, he has made a profit of $10mn.
The venture, it seems clear, made good business and economic sense. The $50mn 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 $50mn 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 totalled 25% of the “loss,” or $12.5mn, the same project’s total cost would jump to $112.5mn. A $110mn sale would then imply a $2.5mn loss, rather than a $10mn 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 aluminium tariffs will.
For the sake of any who share Trump’s flawed logic, the point can be clarified further. The $50mn the developer spent in China was exchanged for $50mn worth of goods. That makes it an equal and balanced transaction. Demanding that China purchase $50mn 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 $50mn following the developer’s transaction, but it would also have a “goods surplus” worth $50mn. 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 $50mn 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 $50mn 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 $800bn annual trade deficit, it is simply because US businesses and consumers choose to purchase $800bn 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 $800bn 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 $14tn 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. – Project Syndicate
* Asad Jamal is the founder and chairman of ePlanet Capital.
LEAVE A COMMENT Your email address will not be published. Required fields are marked*
Did Kerala’s dams exacerbate India’s once-in-century floods?
The sirens are sounding to save the planet
The new disappeared
The martyrdom of Jamal Khashoggi
Reporting on Trump and Putin amid war on truth
Fasting regimens can ‘eliminate’ need for diabetic medication
Use of C-sections growing at alarming rate
Asthma during pregnancy tied to depression risk