U.S. Trade Deficit Increases - Alternative Explanations

by: Bob McTeer

The goods and services trade deficit widened in September, reversing recent improvements. It was good news that both imports and exports increased after a shrinkage of trade resulting from the global contraction. The deficit increased because imports increased more than exports.

Exports or goods and services increased by $3.7 billion to $132.0 billion while imports increased by $9.3 billion to $168.4 billion. The deficit for September increased from $30.8 billion to $36.5 billion, an increase of 18 percent.

The cause of the deterioration is not obvious. Normally faster growing imports than exports would reflect faster U.S. growth than our trading partners. That isn’t the case with our Asian trading partners, especially China. They have been growing faster.

The answer may lie in capital flows that mirror trade flows and can be the driving force rather than just the passive financing of trade. In other words, the trade deficit may be “financing” an increase in net capital inflows rather than the other way around.

This explanation is consistent with what I’ve suggested before – that more net capital inflows (and thus larger trade deficits) may be necessary to make up for the shortfall of domestic saving in financing domestic investment. With huge increases in government dissaving in the form of larger and larger budget deficits, national saving is shrinking. That means either domestic investment has to fall to match lower saving, or more foreign saving will be necessary to supplement domestic saving.

This explanation is plausible, but nonintuitive. Among other things, it suggests that we have to have a larger external deficit because of our larger budget deficit. The positive side of that is that a shrinkage of the budget deficit would help on two fronts: it would help finance and sustain domestic investment and would also help reduce the external deficit and accumulation of U.S. debt by our trading partners.