The other deficit: balance of payments

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SAFE has spent considerable time over the years railing against the government’s budget deficits, and with good reason. But what about the balance of payments deficit, which the president keeps bringing up and proposes to address even if it means starting a trade war?

This entry will assess the implications of BOP deficits, outline the administration’s ideas for combatting them, and review some suggestions for a more promising approach.

I. Background – The US balance of payments (for goods and services) versus the rest of the world has been negative since 1975 according to Census Bureau data. Investment flows are offsetting, so it may be inferred that other countries are investing (on a net basis) in the US by acquiring securities of US issuers, buying real estate, building factories here, etc. Despite the rhetoric, US trade deficit with China is not a big problem, Walter E. Williams,, 5/3/17.

The bulk of our current BOP deficit stems from trade imbalances with China, Mexico, Germany, and Japan.
Data by countries, Department of Commerce (Census Bureau).

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As for budget deficits, the federal government has been running in the red for a long time (the most recent surpluses were in FY 1998-2001 and before that 1969).

Here’s a recap (selected years) of the budget deficits vs. BOP data from 1990 to 2017. Given the importance of China in the BOP picture, we included a goods deficit (couldn’t locate goods & services data) with China line.

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There is no obvious linkage between budget deficits and the BOP, which have often moved in the opposite directions (see, e.g., 2000 vs. 1995, or 2010 vs. 2005). However, cumulative budget deficits from 1990-2017 totaled $11.1 trillion versus a $10.7 trillion BOP shortfall. Was this sheer coincidence, or are these deficits connected at a deeper level?

BOP deficits can be likened to budget deficits in that both reflect a habit of excessive consumption financed by the accumulation of financial obligations that may ultimately result in a default. Thus, Warren Buffet narrated a hypothetical BOP scenario (Thriftville v. Squanderville) in a 2008 film dramatizing the fiscal problem. I.O.U.S.A.,
video clip (3:30).

Several distinctions should be noted, however, which may support a more relaxed attitude about BOP deficits.

*Budget deficits result from the decisions of politicians trying to keep their jobs by gratifying donors and constituents, while BOP outcomes are based to a large extent on decisions of business people trying to earn profits. Wasteful consumption is less likely to occur in the BOP context.

*Some national economies can produce certain goods or services at a lower cost or with higher quality than others, i.e., have a comparative advantage for those goods and services. By specializing in what they do best and exporting a portion of their output, firms in different countries can simultaneously maximize their own profits and contribute to optimal overall results. Hence the “invisible hand” theory of Adam Smith et al. that the self-seeking actions of individual decision-makers nurture the global economy.

*If business firms (or their host countries) underprice products in export markets (aka “dumping”), so what? They are simply harming their own interests, while doing everyone else a favor. If they want to give their products away for nothing, that’s OK with us.

*If Country A runs BOP deficits with some countries it can offset these deficits with surpluses elsewhere. It would not be practical or reasonable to expect balanced trade with every country in the world.

*If Country A runs BOP deficits on a global basis, this isn’t necessarily a cause for alarm. Warren Buffet’s Thriftville vs. Squanderville scenario notwithstanding, the willingness of other countries to invest their money in Country A may arguably work out to the long-term benefit of all concerned. Americans can run trade deficits forever, Tim Worstall,,

[The US has been adding to its] net wealth in recent years (please, please, note this is net wealth, this is after debts are deducted) at a clip of around $5 trillion a year. That is, we're creating new wealth at about 10 times the rate that we're selling it to foreigners to finance our consumption. We can obviously carry on doing this forever. And if we're honest about it we might well say that only consuming 10% of the new wealth we're creating we're not consuming enough of it.

*The US has run BOP deficits for most of its national history, with one major exception – the thirty years after World War II while the rest of the world was in economic rebuilding mode – without any apparent ill effects. Trump, tariffs and the protectionist temptation, Phil Gramm & Mike Solon, Wall Street Journal,

From 1607, when the first English settler stepped ashore at Jamestown, to the beginning of the 20th century, America generally ran trade deficits. As a beacon of economic freedom and opportunity, it attracted foreign labor and capital and generated economic growth on a scale unprecedented in human history. *** Since 1976, America has run trade deficits for 42 consecutive years. During the Reagan revitalization, strong economic growth was achieved even as the aggregate trade deficit as a percentage of gross domestic product quintupled. During the Clinton boom, the trade deficit more than quadrupled as a percentage of GDP. By contrast, during the weakest postwar recovery, 2009-16, the trade deficit barely changed, and in four of the five recessions between 1980 and 2008, the trade deficit shrank.

Convinced? Well, don’t agree too quickly, because the “free trade” model isn’t necessarily representative of how things work in the real world. Trade deficits in the context of state-managed trade and systemic debt, Ilana Mercer,,

Free trade is an unknown ideal. What goes for "free trade," rather, is trade managed by bureaucratic juggernauts—national and international—central planners concerned with regulating, not freeing, trade; whose goal it is to harmonize labor, health, and environmental laws throughout the developed world. The undeveloped and developing worlds generally exploit and pollute as they please.

Also, as Ms. Mercer goes on to suggest, the government’s unfunded liabilities shouldn’t be overlooked in estimating national wealth and the rate at which said wealth is growing.

Americans, reports, actually have more debt relative to income earned than Greeks. "Indebted U.S. households carry an average credit card balance of $15,706, according to NerdWallet." Corporate America is likewise heavily leveraged. [And] the Federal government is the definition of debt. The U.S. national debt is over $20 trillion without federal unfunded liabilities. Those exceed $210 trillion, by Forbes' 2017 estimate.

Even if BOP deficits are benign in themselves, they must be financed and there are limits to the perceived risks foreign investors will accept. Fix trade deficit or risk another financial crisis, Peter Morici,,

Foreign governments and private persons buy U.S. Treasuries, corporate stocks and bonds and real estate in tony locations like Manhattan and Miami Beach, and we have to pay interest, dividends and rent on those assets that grow larger each year. Americans make similar investments abroad, but overall foreigners are buying more here. The U.S. Net International Investment Position (NIIP) is now minus 45 percent of GDP and if large trade deficits persist, the NIIP could reach negative 60 percent over the next decade—likely sooner. In recent years, no nation has reached that level of indebtedness without eventually going through a reversal of its trade deficit, often accompanied by a financial crisis or severe domestic deflation.

Conclusion: BOP deficits may be less toxic than government deficits, but they are properly a subject for concern. The long-standing trade deficit with China is particularly worrisome.

II. Trump trade policies – The president has zigged and zagged on many policy issues, but he has consistently expressed the view that other nations are ripping the US off in the international trade arena and should be called out for it. Time to get tough, Donald Trump, 2015.

We are paying too much for oil imported from countries that don’t like us very much. China is ripping us off by undervaluing their currency (by 40-50%?). [Let’s] impose a 20% tax on “any foreign country shipping goods into the United States.” (International trade benefits the US, and what happens when the other countries start taxing us?)

One of the first actions of the Trump administration was to renounce the Trans-Pacific Partnership (TPP) that the Obama administration had spent years negotiating with 11 other countries. We questioned this action at the time, citing a Wall Street Journal editorial in support of our position. A barrage of presidential actions,

The TPP (now known as TPP-11) is now being implemented without US participation – which arrangement probably won’t work to this country’s advantage. In America’s absence, the TPP goes on, Ed Gerwin, Wall Street Journal,

TPP-11 will be a boon to traders in Australia, Brunei, Canada, Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore and Vietnam. But the deal also has significant implications for the U.S. Under TPP-11, American manufacturers, farmers and service providers will have a harder time competing in key TPP markets, particularly Japan, Malaysia and Vietnam.

Negotiations to revise the longstanding North American Free Trade Agreement (NAFTA) are also underway, with periodic threats from the president to pull out if a “fair” agreement can’t be negotiated. Perhaps such threats are merely a negotiating tactic, but many observers have suggested that the resulting disruption would not serve US interests. Larry Kudlow: Trump knows NAFTA withdrawal would doom stocks, Rob Williams,,

“You’ll knock the stock market down. We’re too intertwined,” Kudlow said on business news channel CNBC. “There's a potential blow up in the stock market if we leave NAFTA. We're talking agriculture. We're talking car parts. We're talking trucking, transportation, energy."

Several rounds of tariffs have been announced in recent months. First it was washing machines and solar panels, which didn’t cause much of a stir. The decision to impose tariffs on steel (25%) and aluminum (10%), however, drew a sharp reaction from many observers – including Republican members of Congress, US business leaders, and again Larry Kudlow.

Wilbur Ross resigned as the president’s chief economic adviser, reportedly due to his disagreement with the steel and aluminum tariffs – which were characterized as a reaction to the dumping of these products and was justified on the basis of US national security. Trump to slap tariffs on steel, aluminum, S. A. Miller & Dave Boyer, Washington Times,

It has since been announced that Mr. Ross will be replaced by Mr. Kudlow, another free trade fan. Also, a number of countries have been exempted from the steel and aluminum tariffs, at least for the time being. Trump’s tariffs take effect Friday, with exception[s], Diana Stancy Correll, Washington Examiner,

Argentina, Australia, Brazil, Canada, Mexico, South Korea, and EU member countries all received suspensions, with final determinations to be hashed out by May 1, the White House announced. [Aside from China, we’re not sure who that leaves on the list.] “These suspensions are based on factors including ongoing discussions regarding measures to reduce global excess capacity in steel and aluminum production by addressing its root causes,” a [White House statement] said.

The big trade news last week was another tariff announcement, this one directed specifically against China. Up to $60 billion per year in tariffs are to be imposed on various products in retaliation for allegedly unfair Chinese trade practices, e.g., forced sharing of US-owned intellectual property. Trump targets China with proposed trade tariffs, S.A. Miller, Washington Times,

Critics pointed out that such tariffs would represent a tax, which would run counter to the Republican tax cut that was enacted with much celebration in December and would probably be passed on to US consumers via higher prices. Proposed Chinese tariffs will raise taxes following a large tax cut, Erica York, Tax Foundation,

Though these tariffs would discourage imports from China, they would also cause direct and immediate harm to U.S. businesses and consumers that could intensify over time if retaliatory actions were taken. There is wide agreement that China’s unfair trading practices need a response; however, the proposal of broad tariffs under consideration is not likely to result in changes in Chinese government policy.

For its part, China shot back that it was prepared to impose retaliatory tariffs on its imports from the US and that no one would win if a trade war resulted. China names 128 US products that could be subjected to new tariffs, Diana Stancy Correll, Washington Examiner,

"We urge the U.S. to cease and desist, make cautious decisions, and avoid placing China-U.S. trade relations in danger with the purpose of hurting others that eventually end up hurting itself," the statement said.

A sharp drop in stock prices was commonly attributed to concerns about the matter. Stocks swoon again; Dow sinks 400,,

Stocks sank again, giving Wall Street its worst week in two years, as fear gripped investors that China and the U.S. were headed for a trade war. The Dow Jones industrial average plunged more than 400 points, bringing its weekly decline to 1,400. *** Traders are worried that an escalating trade spat between Washington and Beijing will hurt U.S. businesses, especially those that do a lot of sales overseas.

Conclusion: Tough talk on trade policy and impulsive policy initiatives aren’t likely to advance US interests. It would be best to think things through before acting.

III. Some suggestions – During the Clinton administration, the US supported the entry of China into the World Trade Organization. The logic was that membership in the WTO would encourage China to evolve into a free market economy. But things haven’t worked out that way. Forget currency manipulation or dumping, the basic problem has been China’s drive to become a high technology economy by bullying multinational firms into sharing their technology. Second thoughts on trade with China, William Galston, Wall Street Journal, 8/8/17.

In 2006 the Chinese government adopted a long-term plan to promote what it called “indigenous innovation.” *** In practice, this meant giving American firms an offer Don Corleone would have recognized—either to “share their technologies with Chinese competitors—or refuse and miss out on the world’s fastest-growing market.” China’s ultimate goal is to use forced technology transfer to replace the U.S. as the world’s leading economy.

A signature technology initiative, “Made in China 2025,” calls for Chinese companies to produce 40% of the components and materials in the manufacturing chain by 2020, and 70% by 2025. This doesn't bode well for high-end manufacturing in the United States, Europe, Japan, [etc.] And existing legal tools may not suffice to end these discriminatory practices. Thus, the WTO prohibits mandatory technology transfers, but China argues that trading technology for market access is purely a business decision.

It seems unlikely that the US could change China’s mind about this strategy simply by imposing punitive taxes on the importation of Chinese goods. China can find other places to sell its goods, transship them through other countries, etc. So to have a chance of winning the game, the US must get other trading nations on its side. Trump has winning hand on China; he just needs to play it, Veronique de Rugy & Christine McDaniel,,

To this end, the administration would do well to adjust its policies in two respects. (1) Stop being trigger-happy about imposing tariffs just because we are running BOP deficits with a number of countries, which does not enlist the trust and cooperation of our trading partners. (2) Reopen the door with TPP, which offered the potential for a US-led Pacific trade bloc that could provide an effective counterweight to Chinese influence.

In other words, the key to pushing for freer trade is multilateral action. Trump, tariffs and the protectionist temptation,
op. cit.

The effective way to deal with China’s steel and aluminum subsidies is to have all the world’s steel and aluminum producers jointly demand that Beijing end them, and then to enforce that demand with unified retaliation if necessary. The way to get China to live up to its commitments to the World Trade Organization on issues such as respecting intellectual-property rights is with U.S.-led WTO action, which in the extreme could expel China from the WTO if it fails to comply. Protectionist actions on America’s part not only hurt our economy but destroy the credibility of U.S. demands that other nations reduce subsidies and enforce WTO rules.

Query: Is the president likely to heed such suggestions? Probably not, but we doubt he will take actions that would risk fundamental harm to the US economy. The most likely outcome is that his protectionist instincts will be so watered down in the trade policies followed that nothing much will change, i.e., the current level of BOP deficits will continue.


I disagree with this comment: “If business firms (or their host countries) underprice products in export markets (aka “dumping”), so what? They are simply harming their own interests, while doing everyone else a favor. If they want to give their products away for nothing, that’s OK with us."

In one industry after another (transistor radios, optics, autos, steel, apparel and many other), products were either dumped or subsidized by foreign governments to penetrate US markets, effectively driving US producers out of business. This is not “so what,” it is unfair trading, which costs jobs and debt service. – SAFE director

Consider this: “If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry employed in a way in which we have some advantage.” The Wealth of Nations, Adam Smith, 1776.

There’s no way the US could have expected to dominate all the global industrial markets indefinitely after World War II, the situation was bound to slip back into some semblance of balance and it did.

Further, as the entry goes on to say, the “free trade” model isn’t necessarily representative of how things work in the real world. The other view is that international trade flows are managed by national and international bureaucrats.

The truth probably lies somewhere between free trade and managed trade, but mercantilism didn’t serve France well in the 18th Century and it isn’t likely to advance US interests in the 21st Century. And while it does seem that China needs to be confronted, the emphasis should be on forcing them to stop stealing technology and open their markets to others versus blocking their sales into the US.

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