Donald Trump believes that US trade deficits are evidence that Americans are being “ripped off” by foreign countries. He’s not alone. Fear and loathing of US trade deficits are bipartisan and long-running. When trade deficits were increasing during the 1980s, Rep. Richard Gephardt (D-MO) demanded higher tariffs, complaining that “we have a trade hemorrhage. We are not getting beaten in world trade. We are getting creamed.”
High US trade deficits, now as then, are said to justify higher tariffs.
Trade deficits arise whenever the amount of goods and services that a country imports during some period – say, one month – exceeds the amount of goods and services that it exports during that period. This fact is popularly taken to mean that trade-deficit countries consume more than they produce, with the excess consumption paid for with funds borrowed from abroad or with assets sold to foreigners. If this were true, ongoing trade deficits would impoverish any country that chronically runs them and be unsustainable. But history casts doubt on this common understanding of trade deficits: Despite the US running annual trade deficits every year starting in 1976 (the year I graduated from high school), the real net worth of American households is today (even though I’m now past the official age of retirement) at an all-time high,* as are real per-capita GDP, America’s industrial capacity, and America’s capital stock.
How is it possible that, in the face of nearly a half-century of uninterrupted annual trade deficits, Americans have gotten richer and our economy stronger?
Since Adam Smith, economists have repeatedly exposed the many conceptual flaws that infect popular discussions of the balance of trade. Perhaps most significant is the failure to realize that trade deficits are matched by capital inflows – or, as they’re called, “capital-account surpluses.” If, as is true for the US, the bulk of these inflows finance investment rather than consumption, the country’s capital stock grows, thus raising workers’ productivity and citizens’ prosperity. To bemoan rising US trade deficits is to bemoan foreigners’ eagerness to invest in America and the resulting growth of our capital stock and productivity.
But there’s another way to see why America’s prosperity has increased despite her long-running trade deficits: Large portions of these deficits are the result of a mere accounting convention – specifically, the convention of classifying international cash holdings as investments rather than as imports of the countries in which these holdings increase. This convention masks an important economic reality.
When foreigners hold US dollars, those dollars are not used to buy American exports. As a result, the US trade deficit grows by the size of these dollar holdings. In balance-of-payments accounting, these dollar holdings are classified as foreign investments in America – technically, as foreigners obtaining American assets. This classification is reasonable, as foreign holders of dollars might anticipate that the dollar’s value will rise against that of other currencies.
Yet it would be equally reasonable to classify these dollar holdings as American exports. Foreigners supply to America large amounts of textiles, steel, and other goods and services that they produce at a comparative advantage in exchange for a service that America produces at a comparative advantage – namely, the services of a relatively stable and especially useful currency.
Services supplied by a reliable currency differ in no essential respects from other valuable services that are classified as imports when purchased from abroad (or as exports when sold abroad) – services such as tourism, education, medical care, and investment advice. Because the US economy is so large and prosperous and has sophisticated financial markets – and because the Fed is relatively responsible compared to most other central banks – US dollar holdings provide foreigners with reliable purchasing power that is unique in its worldwide appeal. There are good reasons why the US dollar is the dominant global reserve currency, accounting for 53 percent of official foreign-exchange reserves.
Therefore, dollars for holding and using abroad are a major American output that we produce and export to foreigners in exchange for goods and services that we import. We should be no less pleased to have a comparative advantage at producing a currency that’s especially useful for global commerce than we are to have a comparative advantage at producing chemicals, IT, or any other good or service. Although in balance-of-payments accounting dollar holdings aren’t treated as an American export, there’s no economic reason why they shouldn’t be. If they were, the measured US trade deficit would be much smaller.
For example, in the third quarter of 2024 America’s reported trade deficit was $233.6 billion. Also in that quarter, dollars held abroad as official foreign-exchange reserves increased by $122.3 billion. If these dollars held as foreign-exchange reserves were counted as American exports, the reported US trade deficit for that quarter would have been only $111.3 billion, or less than half the size of the official reported trade deficit.
Of course, dollars are held abroad also by individuals and private entities, so any precise measure of how the reported US trade deficit would change if foreign dollar holdings were classified as US exports would also have to take account of changes in private holdings of dollars. But this much is certain: were foreign dollar holdings counted as US exports, America’s reported trade deficit would be much smaller – and the pointless fretting about America’s alleged economic “uncompetitiveness” or economic demise much less.
I’m not here proposing that foreign dollar holdings actually be reclassified in balance-of-payments accounting as US exports (although I’d have no objection in principle to any such effort). My point instead is to counsel that greater economic understanding be brought to analyses and use of these accounting measures. Accounting isn’t economics. If ordinary Americans better understood the economic forces that give rise to US trade deficits, they would be less prone to being unnecessarily frightened by this accounting convention and, in turn, less willing to embrace protectionism whenever politicians or pundits scream “rising trade deficits!”
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* The household net-worth figures are in nominal dollars. Converted into real dollars using this GDP-deflator calculator reveals that the real net worth of US households is at an all-time high today (Q3 2024).
