Mega Eye Crosser: Trade deficits and a little bit about exchange rates

Try to bear with me on this one all the way to the bottom of the posting. It may or may not become clearer after the first reading. To coin the phrase “it’s a small, small world after all”, (Walt Disney) we all need each other to make any “trade” deal!

This is such a MEGA MEGA Eye Crosser, what else can I say!!! I will start with a disclaimer. As I mention in my “About” page, I am not an economist. I am an amateur investor (versus a professional trader, etc.). I am writing this blog to help me as well as anyone else who is interested, to hopefully, better understand our current economic conditions and circumstances here in the United States. As I sift through information and resources available on the “web”, I try to choose sources that are credible and have “currency” as far as data and informational quality.

In gathering information for the Trade Deficit topic, I feel that I have truly run into one of the most intertwining mechanisms that bind the entire world populations together. In other words, when one hears or reads of a politician saying he/she will “solve” the U.S. trade deficit situation, be very attentive to their words. Oh, and the Federal Reserve source I used also talks about the Exchange Rate and its influence upon the trade between countries. Of course that makes sense since we are measuring/comparing currencies/ values to make the trade deals. I had not intended to put the two (2) concepts together but, of course, how can one talk about one without the other!

Now, back to the subject at hand, The Trade Deficit:  The terms or concepts of “trade surplus,” trade balance,” and “trade deficit” are all encompassed within another concept called current account balance. In struggling on how to present the concept of trade deficit to you, the reader, I have decided that perhaps definition and relationship of terms would be the way to go.

Balance of Payments:  tracks international transactions of goods, services, and finances. Every international transaction is recorded as both a debit and a credit somewhere in the Balance of Payments. The result of this accounting identity is the Fundamental Balance of Payments Identity, which says that the sum of the Current Account, Financial Account, and Capital Account must be zero by definition.

There are three (3) main components of the Balance of Payments:

  1. Current Account
  2. Financial Account
  3. Capital Account
  1. Current Account: commonly referred to when trade balance is discussed. It reflects comparison of national saving and national investment. Current Account is part of the Balance of Payments first mentioned above.

Current Account Balance:   is difference between nation’s income and expenditures and any additional debt the country takes on to cover the difference. Transactions that arise from exporting or importing of goods and services enter directly into the Current Account.

  • Trade Surplus:  when a country exports more than it imports, (i.e. the difference between exports and imports is positive).
  • Trade Balance:  when a country exports exactly as much as it imports.
  • Trade Deficit:  when a country imports more than it exports.

 2. Financial Account: Countries also engage in trade in financial assets. Transactions that arise from trade in financial assets are recorded in the Financial Account.

3. Capital Account: certain other activities result in transfers of wealth between countries. These are recorded in the Capital Account; for instance, transactions such as non-produced, non-financial, and possibly intangible assets, i.e. copyrights and trademarks).

 National Income Accounting Identity:   the current account balance is equal to difference between national saving and national investment.

When a country has trade surplus (positive trade balance), national savings must, by definition, exceed domestic investment. That is, a country with current account surplus is also net lender (this country uses savings not invested domestically to make loans to foreigners).

When a country has a current account deficit, national saving must, by definition, be below investment. The country is a net borrower (as national saving is not sufficient to finance all of domestic investment, and so extra investment must be financed by borrowing from abroad).

What all of the above is getting at is that the concept Trade Deficit that I thought I would talk about singularly by itself is not a very plausible idea. The Trade Deficit is a result of a multitude of transactions and like the other Current Account items: Trade Surplus and Trade Balance, is a cumulative number. Every trade agreement that the United States signs will affect our “trade numbers”.

Just like all the other mechanisms that make up our economic and/or financial systems, calculations of trade balance are very complex and complicated. Here’s my source from the Federal Reserve Bank of San Francisco, the article  is called:   Is the U.S. trade deficit a problem? What is the link between the trade deficit and exchange rates?

There are two (2) other sources that I will give you. Both of them discuss  the concept Trade Deficit in relation to the United States. They are both short items to read. I think they will help clear the question of is a trade deficit good or bad. We sell products like airplanes, wheat, paper, abroad and the buyer must use U.S. dollars to pay the manufacturer, producer or grower. That’s where the exchange rate comes in. Countries must have U.S. dollars in order to complete a transaction. At the same time, all those U.S. dollars in the hands of other countries must be used to purchase U.S. goods or make investments in U.S. financial instruments. Over the years, China has purchased a multitude of U.S. Treasury bonds, so although we have a huge trade deficit with the Chinese, they also have owned a “ton” of U.S. Treasury Bonds:  CNBC article here.

Trade Deficits aren’t good or bad, just weird by Sabri Ben-Achour

Is the U.S. Trade Deficit Really Bad News?  By Daniel Griswold

Needless to say, getting it right with such a very complicated subject is very difficult. Constructive additions to my posting are welcome.

Author’s Addendum 9/23/2015:  Here is a link to the Office of the United States Trade Representative.  Listed are all the current trade agreements between the United States and other countries.

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8 thoughts on “Mega Eye Crosser: Trade deficits and a little bit about exchange rates

  1. Thanks for your post. I wasn’t aware that the financial account was separate from the capital account. I thought that the current account of a country was balanced by the capital account. If there is a current account surplus then by definition there would need to be a capital account deficit ie an outflow of capital, if the exchange rate is to stay constant. Michael Pettis, who has worked in finance but is now a Professor of economics in Beijing, writes about international trade and financial flows a lot. I have found his blog (China Financial Markets) and books very helpful in gaining a new understanding of the causes of the financial crisis and subsequent recession/depression. He has made some predictions about the problematic future course of the global economy and the necessity for various imbalances within and between countries to be resolved, which will not be easy. If more policy-makers understood and acted on his ideas I think we would be in a better place.

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