Why Is the Trade Deficit Important?

BY busadmin  March 30, 2009 at 6:10 PM EST

container ship; andrew.albertson via Flickr

Question: Please explain the trade deficit. What is it? Why is it important? Is it an indicator like taking someone’s temperature or is it a debt that has to be paid?

Does it relate directly to our national debt? For example, we have a trade deficit with China. Also, we borrow money from China by selling T-Bills. The T-Bill transactions contribute to our national deficit. How does the trade deficit fit into the picture?

Paul Solman: Trading with those outside the United States means selling to them and buying from them. When we spend more abroad than we earn from abroad, THAT is a trade deficit.

Why is it important? Because the money has to come from somewhere and for years, we’ve been borrowing it.

Does it relate to our national debt? Yes, by a slightly circuitous route. When we spend more abroad than we earn, the rest of the world has more of our dollars than we have of their currencies, right? What do they DO with our dollars? They can buy ASSETS in America like the Japanese used to: Rockefeller Center, the Pebble Beach golf course, Columbia Pictures. They can buy U.S. stocks. And/or they can LEND us back the dollars, for which they get – to use ‘Guys and Dolls’ terminology – our “marker”: our Treasury bills, notes, and bonds – our IOUs.

And why does the Treasury need to issue IOUs? To cover our annual deficit, of course, because the government TOO spends more than it earns. Which means that it doesn’t tax us as much as it should. Which means that we have the extra money to buy more stuff from abroad. It also means that our cumulative national debt grows.

So here’s the great daisy chain of being American: We buy more from abroad than we sell. Foreigners – most notably the Chinese in recent years – take our excess dollars and lend them back to us via the government, which can spend more than it earns, which lets us keep our tax money, which we then can the spend abroad.

We paved this trail with Japan in the 1980s. China has simply been following suit.