The Trade Deficit Widens, As It Must

by: Bob McTeer

It was announced Thursday that the goods and services trade deficit widened to $40.29 billion in April with both exports and imports declining.

The decline in exports and imports is a sign of a weak or weakening world economy. The arithmetic, however, makes our growing trade deficit inevitable as long as our budget deficit is growing. They are not independent of each other. They are two parts of a zero-sum relationship.

Business and personal saving are not sufficient to offset the negative public saving, as measured by the budget deficit. Those three forms of national saving fall short of national investment and have to be supplemented by an inflow of foreign saving. Either that, or domestic investment must decline to match the lower national saving.

The necessary counterpart to an inflow of foreign capital is a deficit in the current account—the largest component of which is trade in goods and services. This is why the growth in dis-saving as measured by the budget deficit necessarily draws in foreign saving to make up the difference. In effect, the inflow of foreign capital is not financing our trade deficit; our trade deficit is financing the inflow of foreign capital necessary to make up for the growing budget deficit.

Got it?

If you are looking for good news in this relationship, it is this. Shrinking the budget deficit will help shrink the foreign trade deficit and vice versa. Don’t look for a smaller foreign-trade deficit to reduce the budget deficit any time soon, however, since the recent appreciation of the dollar will tend to widen the foreign deficit from the trade side. A strong dollar right now is good for our pride, but bad for our economic recovery.

Watch what you pray for.