The Goods Trade Deficit Part 2

Last week I discussed the persistent US international trade deficit in goods. I concluded with two points. First, if the goods deficit really is a bad thing, a new approach might be necessary now after 47 years of trying has only made it worse. Second, I suggested that the goods deficit might not really be such a bad thing and that we might focus our policy efforts elsewhere. To make this second point I briefly made some points about trade in services and various assets.

This week I’d like to follow up with the idea that the trade deficit might not be such a bad thing.

To start with, discussions of US International Trade are supported by figures collected by the US Bureau of Economic Analysis and found in what is called the Balance of Payments (BOP). That’s a very misleading term and ought to be replaced by something like Stuff People Don’t Know about International Transactions (SPDKIT).

Even if this is likely to put the Tuna to sleep and cause Nathan to hyperventilate, I am going to educate you goonies about the BOP. I will do this with the below table which reports results for 2017. Once everyone is totally asleep I will then come back to the reason why all this supports my idea that the goods deficit is not such a horrible thing.  

First, the goods deficit of  ($808) billion is shown at the top of the table.

Second, just below the goods numbers are the services numbers. While some people like to say services can be aptly defined by what people at McDonalds do, services is a much broader category with some very sophisticated outputs and very high wage inputs. Services include at least the following industries – travel, transportation, finance, banking, education, retail and wholesale trade. Services account for about 70% of the US national output of about $21 trillion dollars. Notice that we had a trade surplus in services of $255 billion in 2017.

Third, the US is actively engaged in buying and selling financial assets. For example, Germans buy US government bonds and US citizens buy stocks of British companies. The table lists three types of cross-country investments which show purchases of Financial Portfolios, Bank Loans and Deposits, and Direct Investments. Financial Portfolios relate mostly to when we buy each other’s stocks and bonds. Direct Investments are when we buy each other’s companies. Loans and Deposits are self-explanatory.

Adding together the balances of these three financial accounts gives you a total surplus of $353 billion. Adding together the surpluses of these three plus services gives you a total surplus of $608 billion.

Tired of adding and subtracting?

One point of this exercise is that there is much more to international trade than goods imports and exports. Clearly a goods deficit of more than $800 billion has negative impacts. It does directly impact employment and it does manage to send US dollars out of the US. But a surplus in services does just the opposite. It increases jobs in the USA and it brings dollars back into the USA.

The story is similar for trade in assets. The financial surpluses show that foreigners love adding US bonds and stocks to their portfolios and they love buying ownership positions in US companies. The benefits should be obvious. When they buy ownership in companies they make it easier for these companies to raise money for investment purposes.

When foreigners buy US bonds and stocks they strengthen these markets too. As they drive stock prices up they lower the cost of capital to firms. As they buy government and private bonds they lower US interest rates and reduce the US cost of capital.

This latter point is more important than one might think. In the US we don’t love to save. We love to spend. As a result, capital is scarce and the cost of capital is higher than it should be. As foreigners bring their savings to the US they augment or pool capital and make it easier and less costly for us top borrow and invest.

This is getting a bit long so let’s wrap up. There is more to trade and to US health than goods. If we worry too much about goods we might threaten these other valuable activities. If bad policy on goods trade makes foreigners move their savings away from the US, then a lot of Americans will suffer as the stock market swoons and the cost of capital rises. Finally, global competition for US goods is not going to end with China. So long as developing countries want to compete with us and so long as their workers make only fractions of what our workers make, we will have a difficult time competing with them. Rather than bring all this activity home we should decide what we do best and what will sustain our workforce in the decades to come. 

Table (In billions of dollars)

Exports of Goods                              1,553

Imports of Goods                              2,361

     Goods Balance                                    (808)

Exports of Services                              798

Imports of Services                              543

     Services Balance                                  255

US Portfolio Investments Abroad       587

Foreign Portfolio Investments in US  799             

     Portfolio Investment Balance            212

US Loans/Deposits from Abroad       219

Loans/Deposits to Foreigners in US  384 

     Loans/Deposits Balance                     165

US Direct Investments Abroad          379

Foreign Direct Investments in US     355

    Net Foreign Direct Investments        (24)

NOTE: This presentations leaves out several smaller items that compose the US BOP Accounts so that we can concentrate on the main items. This presentation also does not mention that some of these items are part of the Current Account while others are part of the Financial and Capital Account.  

US Deficits in Goods Trade

Trade and protectionism are hot topics. At the root of the discussion is what has happened to the US as a trading partner. There is much to this debate and I won’t handle it all here today. Instead I focus on something that I think is central to the issue – the performance of US trade in goods.

International trade goes well beyond trade in goods. But as it turns out, a key part of what we consider to be problematic for the US is trade in goods. We trade services (like entertainment, transportation, shipping, and tourism) and we engage in a lot of international exchange with respect to financial and real assets (bonds, stocks, bank accounts) but we generally run surpluses in those trades. If we have a large and persistent trade deficit, it is mainly with respect to goods.

So I am back to playing with the data again this week. With trade figures there are choices to make. Much of what we refer to as trade is measured and captured in our balance of payments (BOP) account. There we find the Current Account and the Financial & Capital Accounts that contain information about exports, imports, and so on. These figures are always presented in nominal terms and thus measure changes in both quantity and price. Export and imports of goods and services are also published in our National Income Accounts (NIA) and those measures of trade are very compatible with the way Gross Domestic Product (GDP) is measured. The NIA accounts are presented in both real and nominal terms.

Yikes – too much information. Anyway, I decided to use the NIA measures since they are compatible with the way GDP is measured. I am using the nominal versions because they are somewhat more compatible with the BOP figures. I did a quick comparison of the real and nominal NIA measures and it didn’t change my overall conclusions. Whew. Where’s that JD?

The table at the bottom shows nominal NIA measures of US exports and imports of goods starting in 1964, the year I began studying Industrial Management at Georgia Tech and was introduced to chili dogs at the V in Atlanta. I present data for five years that are separated by 13 year-intervals because 13 is my favorite number (1964, 1977, 1990, 2003, and 2016). These 5 years bracket 1990 which is a demarcation point for the rise of globalization. This allows me to compare 26 pre-globalization years to 26 post-globalization years. Is this fun or what?

The top of the table presents US imports and exports in billions of dollars. Nominal GDP, also in the table, went from about $6 trillion in 1990 to almost $19 trillion in 2016. Some of that increase is because of price increases – with the rest from quantities. But GDP is not the point today – though it gives you a benchmark as to how much the size of the overall economy changed over those 52 years. Goods exports went from $403 billion in 1990 to almost $1.5 trillion in 2016. Imports increased too – from $508 billion to about $2.2 trillion. The net imports (imports minus exports) was $105 billion in 1990 and increased to $778 billion in 2016.

If I stopped right now many of you would have an aha moment. What you would see is the following post-globalization experience: US imports of goods outran our exports of goods and the trade deficit in goods increased dramatically. There are no smoke or mirrors here. This is the kind of information that supports the popular idea that globalization has not been good for the US and that there might be unfairness working against us – be it so-called free trade agreements or cheating or whatever.

But let’s not stop there. In the second part of the chart we display trade in goods as a percent of GDP. In 1964 goods exports were 3.9% of GDP. By 2016 goods exports accounted for twice the share of the economy at 7.8%. But notice that the pre-globalization gain of 2.8 percentage points (from 3.9% to 6.7% of GDP) compared to the 1.1 percentage point gain in the post-globalization years. That is, exports gained as a share of the economy much more before- compared to after-globalization. What about imports? Imports of goods increased 2.7 points before globalization and then 3.4 points post-globalization.

It is true that imports of goods picked up its pace after globalization while exports did the opposite. But notice also that much of those changes came in the 13 years after 1990. During the time from 1990 to 2003, exports fell as a share of GDP while imports rose dramatically. But then in the most recent 13 years we see that reversing as the share of exports increased at more that twice the pace of goods imports.

What can we say?

First, goods trade – both exports and imports were rising as a share of the economy for 52 years – both before and after globalization began accelerating in 1990.

Second, when we compare the data before 1990 with what happened afterward you can see much bigger increases in imports of goods relative to exports.

Third, if we look closer at the data since 1990 we see that most of the advantage of imported goods peaked by 2003 and has reversed since.

What does all this mean? For one thing it means that this is a pretty rich stew with a lot of vegetables. If we combine these numbers with the numbers from last week’s blog post we wonder if some of these trade results have something to do with the fact that so many countries have been narrowing the economic gaps between them and the US.

The 1990s were a time when many countries decided to open-up and use trade as a development tool. These countries wanted to rebuild and become more competitive and many were very successful as we saw in this blog last week. As incomes across the world grew, so did their appetites for goods and the growth of US exports of goods verifies this. But as their incomes grew they also became stronger competitors to the US and our goods imports rose as well.

Since so many countries were starting from very low incomes and poor productivity it made sense for the US to make special compensations or to ignore remaining protections in these countries. US citizens gained many of the benefits as more goods were available to them at lower prices. Lower prices gave US residents more dollars to spend and these people redirected some of these surpluses to US companies and created millions of jobs. The GDP data below show remarkable growth in our economy as some jobs declined while other expanded. 

There are some who think that the US can use its own arsenal of protectionist policies to preserve and restore jobs in the US. But that thinking is short-sighted. Despite catching up many countries still retain much lower incomes and a distinct price advantage that goes with it. Protecting US citizens from low prices on low-skilled goods makes no sense. It’s like sticking a finger in the dyke. What makes more sense is to recognize that the world has changed and that developing countries need to protect their own industries and workers less. Let’s not raise the worldwide level of protection – let’s lower it. 

But what about all those US workers in firms and industries that cannot compete? The answer is pretty simple in principle. Protecting these workers is only a temporary measure so long as the American worker makes $50k per year and foreign competitors make half or less. What makes sense is to encourage other countries to keep catching up with our incomes – and to find ways to better train and retrain our workers to fit better into US advantages in education, science, technology, entertainment, communications, and so on. The data below suggest that the export/import issue started turning in 2003. Perhaps we can keep that alive in the next 13 years following 2016.

Billions of Dollars	1964		1977	1990	2003	2016
Nominal GDP		686	2,086	5,980	11,511	18,625
Exports of Goods		27	128	403	741	1,446
Imports of Goods		40	153	508	1,296	2,224
Net Imports		13	24	105	555	778
As  Percent of GDP		1964	1977	1990	2003	2016
Exports of Goods		3.9	6.2	6.7	6.4	7.8
Imports of  Goods		5.8	7.3	8.5	11.3	11.9
Net Imports		1.9	1.2	1.8	4.8	4.2
Source BEA.gov

Lesson 16: International Investment

Those of you with post-kindergarten training may or may not know that governments keep international trade statistics. Even some of our current presidential candidates know that.  These statistics are found in something called the Balance of Payments Accounts and are found at bea.gov . 

While there are two equally groovy parts to the BOP figures most politicians only know about one part of it, the Current Account. The Current Account is on the top and we wouldn’t expect those people to actually read all the way down to the bottom, right? They are busy people. Also the history of the world and the solar system has emphasized the Current Account so it would be unfair to criticize our politicians for only knowing about the Current Account.

This Current Account is where we publish statistics that have to do with exports and imports of goods and services. We sell Chevys to China and they sell rice and replicas of the Great Wall to us. It’s a cool deal. Some of our political leaders have noticed that our dear country almost always has a deficit in our Current Account. And that burns them. After all – the word “deficit” is not a nice word. If your teacher said you had deficits in your behavior, you would feel injured and probably never get a PhD in science or classical studies. This deficit in Current Account means that we are buying more stuff from other countries than they are buying from us. This is especially true of China and since we have a very long list of other issues with China, our politicians complain and sometimes cry that this deficit with China is worse than Dengue Fever and needs to be stopped.

I have written thousands of posts (I exaggerate all the time) which explain why Current Account deficits are not necessarily bad things and I don’t won’t to repeat all that minutia here. I see the Tuna is already starting to nod off.

This post is about the other part of the BOP Accounts – the part at the bottom that most people ignore. It is the part that our politicians don’t have a clue about. So you should feel very special that I am doing this for you today and send either money or JD to thank me.

The second part of the BOP account is called the Financial and Capital Account (F&C Account). What a name! Can you imagine being in the first grade and having a name like that? No wonder no one looks at this account. But this account is the coolest kid on the block and has a lot to tell us.

The F&C Account records all the financial trades between countries. We don’t usually call these import and exports – instead we talk about outflows and inflows. If China invests in America we call that an investment inflow. We like it when foreigners open up US bank accounts and when they buy our bonds, stocks, and companies. All of those financial inflows are recorded in our F&C Account. At the same time, we also like it when US citizens invest abroad. We usually call that diversification. You don’t want all your eggs in one basket and you don’t want all your investments in US bonds, stocks, etc.

When foreigners invest in America we call that an inflow. When US citizens invest abroad we call that a financial outflow. Globalization means that citizens around the world have become increasingly interested in investments both at home and abroad. 

So as a public service and hopefully for money and booze I will acquaint you with some of the financial flow numbers. Below I will refer to some numbers from a close cousin of the F&C Account called the International Investment Account or IIA (the F&C Account focuses on the one period flows between countries while the IIA reports the resulting total ownership positions). 

As it turns out, there are some looming risks associated with the IIA account that we should be worrying about. Unfortunately our leaders are playing with their bellybuttons and/or are unaware of these trends.

I went to the bea.gov web site and downloaded a spreadsheet of IIA information from 2000 to 2015. Here is some of the information from that download:

                                         2000   2007   2015

US Ownership of F. Assets   7.6    20.7    23.3   

F. Ownership of US Assets   9.2    22.0    30.6
Data is trillions of US dollars
F. stands for Foreign

This little table tells you the following:

·       Globalization of financial markets was very evident in the new century with foreign ownership more than tripling from 2000 to 2015.

·       Most of that increase came between 2000 and 2007.

·       Then the activity slowed – especially with respect to US ownership of foreign assets. After growing by $13.1 trillion in the first period, it grew by $2.6 trillion between 2007 and 2015.

·       Foreign ownership of US assets slowed as well but it still increased by almost $9 trillion between 2007 and 2015.

·       If we focus on the 2007 to 2015 time period we see a much wider gulf – foreigners owned $7.3 trillion more of us than we owned of them. Nearly all of that gap can be explained by what is called portfolio investment (in bonds and stocks). That gap was $1.6 trillion in 2000; $1.3 trillion in 2007; and then $7.3 trillion in 2015.

What’s going on? Why are foreigners so interested in our financial markets?

First, since the financial crisis, the US has done better economically than other countries. A relatively stronger economic profile means more confidence in our financial products. Think Greece, China, and Venezuela.  

Second, think US government deficits and debt that have supplied a lot of investment opportunities to both residents and foreigners. Foreigners gobbled up our huge pile of new government bonds!

Third, while foreign companies did increase their acquiring and merging with in US companies, most of the gap mentioned above came from investments in private bonds, government bonds, and equities.

Fourth, notice that despite the gap, US citizens have shown a strong and growing appetite for foreign bonds and stocks. Despite a financial crisis foreigners continued to buy US assets and Americans continued to buy foreign assets.

What do we make of all this? When the gap is favoring US assets, this implies two important things. First, people need dollars to buy US assets so this has strengthened the dollar. Second, when foreigners buy our assets this pushes our asset prices up and interest rates down. With the huge increases in national debt and the needs of firms to finance their investment projects, this asset demand from foreigners prevented our interest rates from rising/stocks falling and thus helped to keep the US economy growing.  

And this is what concerns me. What happens when things turnaround? What happens when other major countries strengthen and their assets look more desirable to global investors? What happens when our government increases its debt even more as foreigners desert US financial markets? Financial globalization made the US wealthier when the rest of the world was weak and uncertain. Financial globalization will have the opposite impact if the US grows weaker relative to Europe, Japan, China, and other countries. Our politicians have complained loudly about the Current Account Deficit. Just wait to see what happens when buckets of money leave the US to be invested elsewhere. Then we will be clamoring about deficits -- deficits in the F&C Account!  

Lesson 12 Balance of Payments: 2015 Data is in or is it?

As my loyal followers might recall, some of my posts are a tad more educational than others. Those of you who have degrees in silly things like fine arts and biology often appreciate my patient and vainglorious attempts to make every day complicated economic concepts even more complicated. If you look back among the 9,763 stories I have posted in the last 217 years you will see 11 such insightful JD motivated dramas. Today is #12.

Balance of payments is one of those sad macroeconomic indicators that MSW grads from Harvard know nothing about. If you asked all the remaining presidential candidates what BOP means they would probably guess it is the name of a dance invented by Bill Haley and the Comets. So I have chosen a wonderful topic for today’s blog and I want you to know that a test will follow.

BOP is a pretty optimistic and archaic name for data that attempts to record all cross-border or international transactions. Wow – what a goal – to record all international transactions! So let’s start out with the very well-known fact that BOP data are about as accurate as a CNBC presidential poll.  The BOP data is a noble gesture but if you think it is hard to measure how much your kid earned at her Lemonade Stand today, then imagine trying to account for ALL cross border trades in goods, services, stocks, bonds, bank accounts and what the Tuna would refer to as college boys gone wild in Tijuana.

But they try. I won’t defend the methods except to say that people who do this kind of thing are vastly underpaid professionals and most of them care very much about doing a good job. And who would bribe the guy in charge of measuring the exports of Chevy hubcaps to Havana? These government workers are saints and deserve a two-for one coupon at the Colonel Sanders Restaurant of their choice.

Before I get into the nitty gritty, I want to say in all seriously (ha ha) that BOP is the main event these days and helps us to understand things like economic growth, interest rates and so on. For example, BOP changes should help us understand why the dollar rose by 20% last year.  So don’t get lost in the trees – a forest of delicious fruits will unfold if you stick with this. Your life will never be the same. 

Let’s start with the easy stuff. Exports are the goods and services we ship to other countries. In 2015 we shipped $2.2 trillion to our trading partners. Of course we also bought that same kind of stuff from foreign countries and that amounted to $2.7 trillion in 2015. If you music majors can do the math, that means that we had a goods and services trade deficit of about $500 billion in 2015. I had a reading deficit once and that was not pleasant. So you can imagine the anguish when a lovely country like the US has a goods and services deficit of $500 billion. But here is the cool part. This deficit means that there are $500 billion dollars scattered across the world that didn’t want to buy US goods and services. We sent them $2.7 billion but they only sent $2.2 billion back. Thus they are holding $500 billion.

The suspense builds. What did foreigners do with all that money? Probably the first thing that comes to mind is to get rid of it. If you don’t want dollars – then you probably sell the dollars for renminbi or yens or some other currency. If that was the only outcome, then all that selling of dollars would probably cause the value of the dollar to depreciate.

But foreigners have other choices. They can use the dollars to invest in America. In this case invest should be taken broadly meaning they can use the dollars to open bank accounts, or buy stocks and bonds, real estate, a US company or buy a famous US monument like Mount Rushmore or Stone Mountain. If they do that instead of selling their dollars then the dollar does not depreciate and instead the prices of financial assets increase and/or interest rates decrease.

Back to the BOP accounts in 2015. Something called the Current Account measures exports, imports and a couple of other things. The exact deficit in the current account in 2015 was $484 billion after being $390 billion in 2014. Thus in 2015 we left even more dollars around the world.  But the Current Account is only half the fun. This brings us to what is called the Financial & Capital Account. Here is what I learned about the F&C account in 2015. After adding $977 billion to their US assets in 2014, foreigners only invested another $426 billion in the US in 2015. That is quite a turnaround. If I stopped the story there it would appear that in 2015 the dollar should have depreciated since foreigners were not pouring their dollars into US exports or US assets. All that would  make the dollar sound pretty unpopular.

But there is one more part to the F&C Account. That part has to do with US investments abroad. In 2014 US citizens added $792 billion to their foreign asset holdings. In 2015 that number fell to $242 billion. US citizens were investing more at home rather than abroad. Now put these two facts together – foreigners were investing less in the USA and US citizens were investing less abroad. In a crazy uncertain world, money was staying at home!

Cutting through all the numbers – according to the Current Account $484 went out of the USA for goods and services in 2015. According to the F&C account $209 billion came back to the USA to buy financial stuff. Thus there are $275 billion unaccounted for in the usual transactions in the BOP. Where are those dollars and what are they doing? Somehow they must be desired because during 2015 the value of the dollar increased. I think most of us know that global tensions created a healthy appetite for US dollars. But somehow BOP is not fully recording that appetite.

Right now that $275 billion is recorded in the F&C account as a “statistical discrepancy.”  Or in an accountant’s words—we have a $275 billion fudge factor in our accounting. I am guessing that revised data will show more foreigner investment in US assets. One likely suspect is governments who bought dollars in an attempt to depreciate their currencies. Otherwise the BOP data leave it very hard to explain a 20% rise in the value of the dollar in 2015.