Why Do We Need This? cont'd
The most disturbing — and confusing — example from that time is Canada. From the beginning, Donald Trump’s obsession with Canada “ripping us off” was weird because they are actually one of our best trading partners. Take cars, for example. At the beginning of the Trump administration, we were buying more cars from Canada than they were buying from us. But Canada buys the individual parts that make those cars from us. So, all told, our automotive trade with Canada was then about even.
U.S. goods and services trade with Canada totaled an estimated $714.1 billion in 2018: Exports were $360.5 billion and imports were $353.6 billion. Our northern neighbor was our largest goods export market, and our second largest goods trading partner with $617.2 billion in total (two way) goods trade.
The U.S. goods and services trade surplus with Canada was $7 billion. Canada’s Foreign Direct Investment in America was $453.1 billion in 2017, up 19 percent from the year before. According to the U.S. Department of Commerce, U.S. exports of goods and services to Canada supported an estimated 1.6 million American jobs in 2015. We're not seeing the problem. Overall, this looks pretty solid to us.
Donald Trump obviously didn’t share our opinion, because his Canadian obsession lasted right through the end of his presidency. In August 2020, he slapped 10 percent tariffs on aluminum from Canada. He said it was because there was a surge in aluminum coming from Canada, but that just wasn’t true.
Naturally, Canada retaliated against these new tariffs with tariffs of their own, which included bicycles, golf clubs, refrigerators, and other items that contain aluminum.
Contrary to what Donald Trump seems to think, trade deficit doesn’t equal we’re getting screwed. Trade deficits are not scorecards that keep track of who is winning and who is losing or if trade deals are good or bad. This is not a zero-sum game.
Let’s say that China really loves American tractors. They just can’t get enough of our tractors over there! So, China buys $200 worth of our tractors. We, in turn, love us some Chinese fortune cookies. We just can’t get enough of Chinese fortune cookies! So, we buy $100 worth of Chinese fortune cookies.
The difference between these two purchases is the trade deficit (i.e., the gap between how much in goods and services we import from other countries, and how much we export to them). As it stands now in our example, China has a $100 trade surplus and America has a $100 trade deficit.
You’ll notice that no one is winning or losing in this scenario. Remember, we didn’t just write China a check for nothing...we got a lot of cookies for our money!
Although the formal definition of deficit includes one that says the amount of something is too small (which makes us feel like we lost somehow), in practice it’s not necessarily a bad thing. It is true that trade deficits are subtracted from the Gross Domestic Product (GDP). Therefore, on paper at least, if one country is selling less stuff, they are likely producing less, which means there are potentially less jobs. But in reality, that is not necessarily true. The United States had a large trade deficit in 2009 when the unemployment rate was 10 percent but had an even larger trade deficit in 2006 when the unemployment rate was just 4.4 percent. The trade deficit is actually more a function of the value of the U.S. dollar...more on this in a minute...
Isn’t this fun!?! Now, there is a flip side to all of this that many people fail to take into account, and it’s major. When we last left our tractor/fortune cookie trade, China had a $100 trade surplus. So, what are they going to do with that $100?
Well, they can do one of two things: 1) They can do nothing and just keep the money in their back account. However, this will just increase the value of their currency and ultimately push their domestic prices upward…OR…They can 2) Take the $100 and invest it back in America through stocks, bonds, or direct investment (i.e., plants, equipment and real estate).
We know this is confusing, but The Economist explains it way better: “It is as if container ships arrived at American ports to deliver furniture, computers and cars, and departed filled with American stocks and bonds. Over time, those assets yield returns in the form of interest, dividends and capital gains.”
This is a really positive development because foreign investment is critical to our economic growth. When you read this next part, don’t forget that in this scenario, China is investing the money we pay them for their goods back into America through stocks, bonds, or direct investment.
The Economist continues, “To the extent that trade deficits thus represent borrowing from abroad there is some truth to the idea that they could erode American wealth. But that is to ignore a crucial point about the debt incurred: it comes cheap. America has run current-account deficits — which are substantially driven by the balance of trade — almost every year since 1982. As a result, foreigners own American assets worth $8.1 trillion more than the assets Americans own overseas, a difference equivalent to 43% of America’s GDP.”
Now, back to what we mentioned earlier about the trade deficit being more a function of the value of the U.S. dollar:
One of the most important things to keep in mind is that trade deficits are a little different for the United States than other countries because our currency is the dominant global reserve currency — meaning the U.S. dollar is used in many transactions that the United States has nothing to do with.
Many countries trade with one another — and borrow and lend — using the U.S. dollar. This increases the demand for our dollar on foreign exchange markets which, in turn, makes it stronger. A stronger U.S. dollar, in turn, makes our exports more expensive and imports less expensive — which ultimately makes our exports less competitive and leads to an overall trade deficit.
Not to get uber dorky, but this is called the Triffin Dilemma: “Incessant foreign demand for a reserve currency forces its issuing country to run persistent current account deficits. The United States, for example, enjoys the consumption benefit of running a trade deficit, while the rest of the world benefits from the additional liquidity, which helps facilitate trade. The cost comes from the declining value and credibility of any currency which runs a persistent trade deficit — eventually leading to a reluctance of creditors to hold the reserve currency.”
This Triffin Dilemma thing sounds tricky — but as a country we want this role. It gives us unparalleled power in global finance, not to mention lower interest rates and a strong stock market. And, lucky for us, foreign investors have no reluctance to hold our currency at this point (this is another reason why being fiscally responsible is so important). In fact, United States Treasuries are still one of the safest bets in the world.
Because of our currency’s position in the world, the United States running a trade surplus could actually upend the entire global market. That sounds dramatic but remember that, in the past four decades, the United States has had current account surpluses in only three years — 1980, 1981 and 1991 — and each of those years was tied to a recession.
As long as the American economy is growing faster than those around the world, our trade deficit will likely increase. Strong domestic growth increases America’s demand for imports while, at the same time, weaker foreign growth decreases the world’s demand for America’s exports.