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….. the fiscal (government) deficit in the US cannot go away unless we also deal with the trade deficit. As we will see, it is a simple accounting issue, and one based on 400 years of accepted accounting principles. - John Mauldin

Trade deficit is currently a headwind to GDP. This is as obvious as:

GDP = private consumption + gross investment + government spending + (exports − imports).

In 2011, the trade balance headwind to GDP was more than a 0.5% drag.

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It does appear as if there is some correlation (although far from perfect as you look at the divergence during the 1990s) between the yearly USA Federal debt growth and trade balance.

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If one steps further back, the cumulative trade balance deficit and US Federal deficit are growing somewhat at the same pace.

(click to enlarge)

The equation leading to this belief in the association between debt and trade is:

Domestic Private Sector Financial Balance + Governmental Fiscal Balance - the Current Account Balance (or Trade Deficit/Surplus) = 0

This is the central exhibit of Wynne Godley's sectoral balance work of the 1980s and 1990s (for which some think he would have a Nobel Prize had he not passed away too soon). The problem is:

  • the world economies are now globalized,
  • the USA economy is not the only game in town,
  • all these equations treat economies like they live in separate bubbles,
  • the dollar itself is the global currency with massive use outside the boundaries of the United States - and this global use is not part of GDP,
  • the dollar is a fiat currency - and unlike a backed currency, its dynamics do not need to add up (1 + 1 = 3).

The equation for the trade balance since at least 2000 for the USA is:

Global Dollars spent = Global Dollars received

As the US has globalized, the trade deficit (or surplus) would be disconnected from internal economic measures such as financial balances or even GDP. This is one reason I continue to talk down GDP as a measure of the economy as the trade balance is an element of GDP.

This does not mean debt is not an issue. Over the entire global economy today, about 35-40% of GDP goes to pay interest. How unproductive is that? Debt is likely limiting economic growth in the USA.

Nor does it mean the trade balance is not an issue. No economy should be dependent on another for a significant portion of a strategic product, and no matter how you cut it - import imbalances are depriving deficit countries of jobs. Most of the USA's trade balance problems are regulatory, and allowing an untaxed imported product to sit next to a taxed USA product.

The USA Federal debt is unlikely a product of trade imbalances - and more likely the inability of the elected officials to do the job they were elected to perform. The USA has a fiat currency, manages it like a backed currency - and then refuses to balance revenue against expenditures. Go figure.

My weekly summary of economic releases this week is in my instablog. The main topic is the Fed's new quantitative easing initiative.

Source: The Trade Deficit Grows The U.S. Debt