We Do Not Have a Trade Deficit, We have a capital surplus

‘Thank goodness for Kevin McCarthy!” isn’t something one says every day, but in the matter of President-elect Donald J. Trump’s backward and destructive plan to resurrect 19th-century tariffs, the gentleman from California is invaluable.

Trump wants to impose 35 percent tariffs on . . . somebody. He does not seem quite sure. One of the reasons for that is that Trump has the question of trade deficits mixed up in his head with the question of offshoring and, like most Americans, he does not understand either of them very well.

The president-elect, writing on Facebook (because that’s what presidents-elect do now), insisted: “Any business that leaves our country for another country, fires its employees, builds a new factory or plant in the other country, and then thinks it will sell its product back into the U.S. . . . without retribution or consequence, is WRONG!” (Eccentric punctuation and capitalization the president-elect’s.) “There will be a tax on our soon to be strong border of 35 percent for these companies wanting to sell their product, cars, A.C. units etc., back across the border.”

Pretty tough talk for a guy who just oversaw a multi-million-dollar corporate-welfare giveaway to Carrier as his first semi-official act.

It is not clear that the federal government even has the power to do what Trump proposes — to lay on a punitive tax based on offshoring decisions, as opposed to laying on a general tariff — but Representative McCarthy has made it clear that congressional Republicans are not much inclined to follow Trump down that particular rabbit hole, preferring to work on such less exotic measures as corporate tax reform that would make investing in the United States a more attractive proposition.

Of course, investing in the United States already is a very attractive proposition, which is — almost everybody gets this wrong – the main reason why we have trade deficits.

Trade deficits are partly a question of consumer preference — American consumers really do like Hondas more than Japanese consumers like Buicks — but they are not mainly a question of consumer preference. They are mainly a question of investor preference — and investors prefer the United States, which is why there is almost twice as much foreign direct investment in the United States as in China, even though China’s economy has grown at a much faster rate over the past 20 years.

It works like this: Almost every advanced country does a great deal of international trade. They have lots of imports and exports because it is easier to grow sugar in Florida than it is in Norway and more efficient to sew T-shirts in Bangladesh than it is in Switzerland. When Walmart orders $1 million worth of flip-flops from a Chinese concern, those Chinese gentlemen receive 1 million delicious U.S. dollars, which they are very happy and grateful to have. But what can you do with U.S. dollars? You can buy stuff from U.S. companies or you can buy assets from sellers who take U.S. dollars, which ultimately means U.S.-based investments. (This is true even when you add in all of the real-world complications such as foreign exchange.) If you are that flip-flop entrepreneur in China, you probably have a very high rate of savings, which is normal for people in poor, backward, and unstable countries. There is lots of uncertainty in a place like China, and having a whole lot of savings — especially dollar-denominated assets — is a rational response to that.

But it isn’t only the Chinese. The Japanese, the British, the Germans and the other Europeans, the Canadians, the Mexicans, and practically everybody else in the world with a little bit of coin to invest likes to buy American assets. And why wouldn’t they? The American economy is the most wondrous thing human beings have ever managed to do, and all it takes to get yourself a piece of it is a few greenbacks.

The mystery isn’t why so many foreigners want to invest in U.S. assets but why Americans invest so little.

Trade deficits don’t happen because the wily Japanese juke us on trade policy. They happen because intelligent people holding a fistful of dollars very often decide to forgo the consumption of American consumer goods in order to invest in American assets. In economics terms, what this means is that the trade deficit is a mirror image of the capital surplus. A capital surplus isn’t necessarily an unalloyed good (everything in economics is about tradeoffs), but it is a pretty nice thing to have around if you are, say, an entrepreneur looking to build a new facility in Houston or Jacksonville and looking for some investors to stake you.

If the economists are correct and trade deficits are mainly driven by investment preferences rather than consumer preferences, what would a big Trumpkin tariff actually do? Daniel Griswold of Cato considered the case back during the 1990s trade panic: “Slapping higher tariffs on imports will only deprive foreigners of the dollars they would have earned by selling in the U.S. market. This, in turn, will reduce the supply of dollars on the international currency market, raise the value of the dollar relative to other currencies and make dollar-priced U.S. exports more expensive for foreign buyers, thus reducing demand for our exports. Eventually the volume of exports will fall along with imports, and the trade deficit will remain largely unchanged.”

The trade deficit might remain unchanged, but there would be a large cost attached: Without that foreign investment capital flowing into the United States, money gets more expensive. That means entrepreneurs have a harder time raising capital.

Having a fat taxman and starving entrepreneurs is not a model for prosperity — the opposite is.

One of the problems, I suspect, is that people hear the word “deficit” and they think of the trade deficit as being like the budget deficit, i.e. a mounting debt that one day will have to be paid. It is something closer to the opposite: We get more stuff in return for the stuff we sell, and we get cheap investment capital on top of that. Foreigners get access to a dynamic economy with a stable government (miraculously stable, considering the jackasses in charge of it) and a stable currency. Everybody benefits.

But of course everybody benefits: Trade does not happen between countries (which is why “trade deficits” are kind of a mirage, anyway, a chimera of aggregation) but between buyers and sellers, each of whom stands to gain from the exchange — if it were otherwise, the exchange would not happen. That’s the really nifty thing about voluntary exchange.

Someone should explain this to the president-elect, assuming it is possible to explain things to him.

— Kevin D. Williamson is National Review’s roving correspondent.

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