BUNK 48
TRADE DEFICITS MAKE DEFICIENT MARKETS
Do you know the US has a trade deficit? A huge one?
If not, you must be an aggressive Luddite, eschewing any form of modern interaction for fully the last 30 years. It was $504 billion at the end of 2009.1 The world’s largest! The story goes: Our big trade deficit means we buy more than we sell. That profligacy weighs on our economy and stocks. Then, that big trade deficit hurts the dollar, weakening our currency relative to the world.
Nonsense! The word “deficit” shares a Latin root with “deficient,” but when it comes to trade, deficits aren’t deficient. Thinking globally frees you from this fear—standard debunkery. Stocks are highly globally correlated, and globally, all trade balances. By definition it must.
No one frets North Dakota having a trade deficit to California. North Dakotans like getting fresh produce in the winter and think the value they get by not subsisting on local barley and sunflower seeds through the long winter is well worth the money sent to sunny California. No one frets municipal debt based on state trade deficits or prefers municipal debt from states with state trade surpluses.

You Are Your Own Trade Deficit

Think it through another way: In one sense, you, personally, are a walking trade deficit. You go to the grocery store and buy milk, tomatoes, and macaroni and cheese. But you don’t sell the store anything in return. You just give them money! Egad! You must be bankrupt! You know that’s silly and that it’s an apples-oranges comparison in terms of your real and overall financial accounting and well-being. But so are national trade deficits, as I’ll show you.
You have money because you do something else to earn money. You could grow your own tomatoes and make your own pasta and cheese. But unless you’re a professional farmer, you know your time is better spent working at a job you’re better at and that takes advantage of your specialization of labor than cheese-crafting. So you take your salary and decide where and how to spend it on stuff you need and want, creating a trade deficit with the grocery store, the home electronics store, the liquor store—and all stores wherever. But you don’t think it would be better if, instead of giving the grocery store money, you stayed home and raised chickens to barter. No! You think that is crazy and rationally understand why the current arrangement makes more sense. The great British economist David Ricardo (1772-1823) proved that specialization of labor is not only good for you—which you intuitively know—but it’s also good for nations, which isn’t always so obvious to everyone. But it’s true. Why?
Because, nationally, it’s not much different from you earning income elsewhere and spending it how you choose at the grocery store, liquor store, whatever-store. Our huge trade deficit, instead of being harmful, can be seen as evidence of long-term economic vibrancy. We have a huge income so we can afford to import more than we export. That’s different from spending more than we make.

Scale It to See It

But maybe you still don’t buy it. Fine—$504 billion is big. But an easy debunkery is scaling big, “scary”-sounding absolute numbers to see them correctly. Our brains are naturally scared of big numbers—part of the way our brains evolved. Big is scary, small is less scary. It makes sense when a mammoth is charging you versus a bunny rabbit—a charging mammoth hurts while a charging bunny is just weird. But that intuitive thinking is all wrong for capital markets. After all, the US is a big economy—over $14 trillion! So consider the trade deficit as a percentage of GDP—the proper way to think about it. It’s currently about 3.5 percent.2 Now, is that big or small? Depends!
Do you think the UK has a big trade deficit? Folks probably never think about it. If they do, they just assume that the US is bad and everyone else is sainted. But no, the UK now has a bigger trade deficit than the US—about 5.9 percent of GDP.3 Though bigger now, since 1980, both great Uniteds have had very similar-sized trade deficits as a percentage of GDP on the same trajectory. And they’ve both shrunk a bit from recent highs. That’s not a great thing—it’s likely tied to the recent recession. You don’t want a smaller trade deficit if it takes a recession to get there.
Figure 48.1 Trade Balances—Would You Rather Be the US or Germany?
Source: Thomson Reuters, visible trade balances as a percentage of GDP from 01/01/1980 to 12/31/2009.
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Figure 48.1 shows balance of trade as a percentage of GDP for the US, UK, Germany, and Japan—currently the largest developed nations. You see the US and UK closely tracking each other with trade deficits nearly the entirety of the last three decades. Japan has had a surplus nearly the entire time, and Germany all of the time, with a big surplus now.

Which Country Would You Rather Be?

Now, which country would you rather be? Since 1980, the US averaged 2.8 percent annual real GDP growth, and its stocks have annualized 10.3 percent.4 UK GDP has annualized 2.1 percent and stocks 11.0 percent.5 If a trade surplus is so helpful, then Germany and Japan should have had better growth and market returns. Except Japan had 2.2 percent annual growth—basically lagging the US and in line with the UK.6 And Japan’s stocks annualized 7.0 percent7—lagging big-time. German stocks did 9.5 percent8—better than Japan, but still lagging the US and UK. And German growth averaged just 1.7 percent!9 A surplus isn’t necessarily so good. A deficit just sounds bad, but isn’t.
Their big surpluses haven’t helped them any more than our big deficits hurt us. In fact, one could argue, because Germany and Japan have heavy government throttles to promote big surpluses, the government intervention in free markets has actually held back their growth, depriving them of the magic of relatively more free markets that exist in the two great Uniteds. At least that’s what David Ricardo would have predicted and smiles at from his grave.
Plus, during the entirety of the time the US has had those deficits, we’ve had periods of strong growth, plus a few recessions. And we’ve had tremendous market growth, plus some bear markets. Yet the trade deficit keeps going, regardless. If a trade deficit were truly all that bad, our economy and stocks would surely have primarily dropped for the last 30 years. They haven’t. Instead they’ve led the developed world.
What about the charge a trade deficit depresses the dollar? Wrong. Here’s how you know. For the last 30 years, we’ve had periods of dollar strength and dollar weakness—no correlation with the size of the deficit. But for almost that entire period, the pound sterling has been very strong—one of the developed world’s strongest currencies. So, to say our big deficit is bad for the dollar, you’d have to also argue that Britain’s equal-sized and sometimes bigger deficit as a percentage of GDP is good for the pound sterling. But you can’t argue that because you can’t have it both ways. That would be crazy.
Simply said, if we grow faster than they do, we can afford to buy more from them than we export to them. End of story. And, even now in 2010 as I write, while we’re not growing faster than everyone, like the emerging-market nations, we are growing faster than most of the developed world, including Europe and Japan, and the non-emerging, less developed nations. And growth comes from letting the free-market magic transform us in its classically creative-destruction-and-resurrection mode that has fostered the greatest human transformation ever seen since capitalism emerged from mercantilism in the early nineteenth century—when David Ricardo was getting older and no longer feeling his oats but seeing the emergence of his views around the world. Growth allows for trade deficits. Lack of growth allows for stagnation and misery all around.
Few bother to think these things through. They just say, “The trade deficit is big and bad,” because deficits sound bad and don’t bother to check if it’s true. Debunkery helps you see this right. Lose your fear of deficits. Instead say, “I love big trade deficits and want to see bigger deficits, not smaller.”
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