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How Important Is the U.S. Deficit in Traded Goods in Regard to the Balance of Payments?

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President Donald J. Trump has made reducing the U.S. trade deficit, which has expanded significantly in recent decades, a priority of his administration. He and his advisors argue that renegotiating trade deals, promoting “Buy American” policies, and confronting China over what they see as its economic distortions will shrink the trade deficit, create jobs, and strengthen national security.

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Economists disagree on the simple question of whether sustained trade deficits are good, bad, or don't matter much for a country and its economy. That's because there are so many variables—so many ways to generate a trade deficit and so many ways it might help or hurt an economy, or reflect good or bad aspects of that economy. A trade deficit occurs when the value of a country's imports exceeds the value of its exports—with imports and exports referring both to goods, or physical products, and services. In simple terms, a trade deficit means a country is buying more goods and services than it is selling. An overly simplistic understanding means that this would generally hurt job creation and economic growth in the deficit-running country. This view of trade deficits is behind much of the complaints among U.S. politicians about bilateral U.S. trade deficits, especially with China, the country with which the U.S. runs what is by far its largest bilateral trade deficit. That deficit was a prominent campaign theme for President Donald Trump in 2016, and a primary reason he launched a trade war against China after taking office. Trump argued that cutting the trade deficit would create jobs in the U.S. and strengthen the economy.To many in the world of economics, though, a trade deficit is about an imbalance between a country's savings and investment rates

It means a country is spending more money on imports than it makes on exports, and under the rules of economic accounting it must make up for that shortfall. The U.S., for example, can do so by either borrowing money from foreign lenders or permitting foreign investment in U.S. assets.

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Should there be a correction to the U.S. current account, it is an abrupt (rather than gradual) correction that many fear. Experiences of the Mexican crises of 1981 and 1994 and the East Asian crisis of 1997 come to mind, when consumption, investment, and output in these nations contracted quickly, asset prices deteriorated, wealth declined dramatically, and their banking systems faced many difficulties. However, it is important to keep in mind that the evidence from developing countries may not be directly applicable to the U.S., a developed nation with an advanced economy. Existing evidence from developed countries suggests that the current account adjustments in industrialized countries have much milder consequences (Croke, Kamin, and Leduc 2005). Over the years, many explanations of the persistent U.S. trade deficit have been proposed

Let me give you a brief review of some of the points that have been raised.By the national income identity discussed above, a trade deficit is caused by a change in national saving or investment or both. U.S. national saving began declining in the 1950s, and this decline further accelerated in the 1980s. Both federal government and personal saving declined during the period (CBO 2000, p. 9). The growing U.S. budget deficit has been blamed for the widening trade deficit because of the so-called "twin deficit" hypothesis (which states that budget deficits cause trade deficits).

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In the final analysis, trade deficit is the result of importations greater than exportations. To pay for the importations, U.S. businesses and consumers inject US dollars into the exchange currency market. They change their US dollars into other currencies and pay for the importations using the currency of the country from which they make importations. The country that exports has in hand, an excess of US dollars (importations greater than exportations) that it keeps in reserves

But those reserves have to be used and not left idle. The country will use the reserves currency to pay for its own imports and/or make investments.

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Bernanke, Ben S. 2005. "The Global Saving Glut and the U.S. Current Account Deficit." Remarks by Governor Ben S. Bernanke At the Sandridge Lecture, Virginia Association of Economics, Richmond, Virginia.

CBO. 2000. "Causes and Consequences of the Trade Deficit: an Overview." Congressional Budget Office.

Croke, Hilary, Steven B. Kamin, and Sylvain Leduc. 2005. "Financial Market Developments and Economic Activity during Current Account Adjustments in Industrial Countries." Board of Governors, International Finance Discussion Paper 2005-827.

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