America's Trade Deficit Should Be Bigger, Not Smaller

Imports cost money and earn resources. Exports earn money and cost resources.

It’s fairly clear that Donald Trump has no idea how trade deficits work. But then again, few of his critics do either.

Trump has repeatedly argued that America’s trade deficit, which results from the country importing far more than it exports, means that the US is ‘losing’ at trade. Apparently, the situation is so disastrous that it constitutes a national emergency. Trump’s sweeping and chaotic tariff policy is driven by a desire to bring the US to balanced trade — or even a surplus.

To the extent that this position is grounded in reason, it appears to be motivated by Trump’s belief that a trade deficit involves the US shipping money abroad. In a narrow sense, Trump is correct; imports really do involve America sending money to foreigners. But the most common criticism of Trump’s position, that America gets something in return for its money, doesn’t go far enough.

This argument paints international trade as a largely neutral transaction, similar to buying produce at the grocery store. In this telling, because both buyer and seller can benefit, neither trade surpluses nor deficits are inherently good or bad. But this is wrong — trade deficits are a good thing, and the US should actively strive to maximize its own.

To understand why, we need to move beyond a money-focused framework for international trade. Money is nothing more than an exercise in bookkeeping — resources are what truly matters. And while imports may cost America money, they earn us resources, providing enhanced capacity to improve our standard of living and material well-being.

Beyond Money: The Resource Model of International Trade

Suppose that in any given year, the humble nation of Ruritania is capable of producing 5 million steaks, half a million vehicles, 10 million paperback books, and a particular quantity of all other goods and services. Currently, Ruritania’s factories and workers are operating at full speed, with zero excess capacity. Human desire being what it is, however, the voracious Ruritanians demand more stuff than their domestic resources can supply.

As a result, Ruritania turns toward its smaller neighbor, Freedonia. Currently, Freedonia’s productive capacity is not being fully employed, as the nation is weathering a recession.¹ Therefore, Ruritania contracts with Freedonia to purchase 1 million flat-screen TVs annually, to be manufactured using the idle Freedonian factories.

This basic narrative hints at a fundamental reframing of how we should think about imports & exports. In this telling, the TVs aren’t just TVs — rather, they represent the embodied resources that went into their production process (land, labor, and capital). Essentially, the TVs reflect Ruritania co-opting Freedonia’s resources for its own material benefit, rather than those resources being directed toward production that could benefit Freedonia’s residents.

In this framework, it should be fairly obvious why a country wants to import things. Imports allow the Ruritanian residents to consume more stuff than their domestic production alone would allow.² The reason why Freedonia wants to export things is a bit more subtle; selling exports allows the country to augment domestic demand with international demand, which can reduce unemployment if domestic demand is insufficient to keep productive capacity fully engaged.

This boils down to a strong pro-import argument: imports allow a country to achieve a higher material standard of living without requiring utilization of that country’s domestic resources. But in practice, the situation is more nuanced. To see why, we need to reintroduce the role of money within this resource-based framework.

Monetary Critiques of Resource Trade

Let’s first consider the case of a normal, everyday individual in the context of import markets.

In order to purchase an import, an individual first needs to acquire money to pay for it. Assuming they aren’t a thief or a counterfeiter, the main way for this individual to acquire money is by working a job — that is, supplying their labor. Thus, to the extent that purchasing imports first requires buyers to have money, it seems that imports still use up domestic resources, despite my claim to the contrary.

Moreover, this argument highlights another potential issue with imports — the idea that international purchases can drain demand from domestic goods & services. Assuming that this individual isn’t importing particularly esoteric goods, they probably have the option to purchase a domestic substitute instead. By choosing to purchase an import, they reduce domestic demand, which could have deleterious effects on a country’s economy.

But as it turns out, these counterarguments aren’t so compelling when we look beyond the individual.

Money is scarce — but not for everyone.

I don’t deny that these concerns are relevant in the context of a private entity (whether an individual, a household, or a company). For the private sector, money is a scarce resource — not only does it first have to be earned, but spending it in one place naturally means you can’t spend it in others.³ But while money may be scarce for the private sector, it’s not scarce the economy as a whole.

Specifically, for a government that issues its own currency, money is an unlimited resource.⁴ The governments of the US, UK, Japan, and many others are capable of manufacturing their own currency out of thin air to finance public sector spending — without first engaging domestic resources. This idea has the most direct implications for fiscal deficits, but it also matters for trade deficits.

It seems obvious that imports are capable of improving a nation’s standard of living beyond what is allowed by domestic resources. For a private sector entity, however, acquiring these imports almost universally involves sacrificing domestic resources, as embodied by its monetary holdings. It is the fact that a currency-issuing government can purchase imports without needing to first ‘earn’ money (and thus utilize domestic productive capacity) that can make expanding the trade deficit such a desirable policy.

And there are a range of intriguing policy options that can help achieve this. Most obviously, the government can simply conduct a vast import campaign, using the acquired resources for the public’s benefit. Alternatively, to preserve consumer choice, the government can offer an import tax rebate to residents, essentially financing the purchases of international goods & services up to a certain amount.

Of course, such a policy needs to be paired with measures that ameliorate the potential knock-on effects for domestic demand. But once again, a currency-issuing government has the tools to address this. Even if demand for domestic goods & services falls as residents substitute with international items, the government can always keep a country’s resources fully engaged by ramping up domestic spending — unemployment is a policy choice.

Exorbitant Privilege: The Dollar’s Global Status

There’s one final consideration we need to discuss that the preceding section glosses over: currency effects.

It may be true that a country like Japan, by virtue of being a currency issuer, could print yen to pay for imports. Unfortunately for Japan, however, very little international trade is conducted in yen. The yen is the currency of choice for just 4% of export invoices. As an intermediary step before acquiring imports, Japan will first need to convert its yen to a currency that’s more acceptable in terms of international trade — classically, US dollars.

Foreign exchange rates are determined by more nuanced factors than simple supply and demand. Nonetheless, it seems incontrovertibly true that the Japanese government printing substantial yen to purchase dollars would likely end up strongly weakening the yen in terms of dollars. This exchange rate depreciation would mean that imports become more expensive in real terms, with particularly negative effects on the currency-scarce private sector.

And yet this discussion also reveals why the United States is a special case. Since the dollar is the global reserve currency, America’s money is international money. The dollar remains the world’s dominant export invoicing currency, especially when ignoring intra-EU trade (where the euro dominates). It’s not a huge exaggeration to say that the dollar is the only currency that can be used to purchase any good or service in the world.

The fact that America can pay for imports in its own currency doesn’t mean that we can ignore the role of foreign exchange entirely. Foreign firms exporting to the US and receiving payments in dollars may sell those dollars to acquire local currency — although the fact that every seller needs a buyer and that several exporting countries take steps to sterilize such transactions makes the exchange rate impact nuanced. In practice, foreigners often prefer to keep their dollars in dollar-denominated investment assets, as evidenced by the $8.8 trillion in off-shore Treasury holdings.⁵

America’s exorbitant privilege isn’t just that we can purchase imports from foreigners in dollars. It’s also that we can offer an ultra-safe interest-bearing savings vehicle for those foreigners to park their dollars in (namely, Treasuries). So long as the dollar remains the currency of international trade and investment, foreigners have good reason to hang on to their dollars. And there’s a virtuous cycle at work here — the larger America’s trade deficit, the more dollars end up in the hands of the rest of the world, further cementing the dollar’s reserve currency status.

Conclusion: America’s Global Fiscal Space

To understand exactly why America is in such a unique position to expand its trade deficit, it helps to think in terms of a government’s fiscal space — the amount of productive capacity currently sitting idle. Fiscal space reflects the dormant factories or unemployed laborers that could be put to work on socially useful projects if only there was sufficient demand. For most governments, fiscal space is a purely domestic concept. But for America, it’s a global one.

Because so many goods & services can be acquired for dollars, idle resources almost anywhere in the world can be put to work by America. For instance, the US could import Chinese steel amid the ongoing supply glut and hire dormant Canadian steelworkers on temporary visas to make repairs to America’s public infrastructure, all at very little cost to our own domestic resources. If you’d argue that those jobs should instead go to dormant American steelworkers, then congratulations — you’ve recognized the unique role a currency-issuing government can play in eliminating unemployment and improving well-being by boosting demand.

Donald Trump is wrong to think that trade deficits are inherently bad, but most of his critics are also wrong to think that trade deficits are inherently neutral. If we place value on the American government having the capacity to improve the American people’s standard of living, then trade deficits can only be seen as a good thing.

1. To explain the country’s idle resources, we might further assume that Freedonia does not have the authority to print its own currency, like nations in the eurozone. This would place a genuine financial constraint on the Freedonian government’s ability to stimulate domestic demand.

2. It’s also possible that there is stuff that Ruritania simply doesn’t have the capacity to produce domestically, either due to limitations of natural resources (like oil) or manufacturing expertise (like high-grade lithography machinery).

3. Even this treatment is somewhat inaccurate to keep things readable. In fact, banks are a private sector entity for whom money is not a scarce resource. For instance, a bank could extend a loan to a business to purchase international supplies, resulting in money creation (specifically deposits) to finance imports. However, relying on private money creation to continually expand the trade deficit isn’t sustainable in the long-term — bank deposits are liabilities, resulting in an increasingly levered private sector.

4. More formally, countries with ‘monetary sovereignty,’ meaning a currency-issuing government with no external constraints (including a floating exchange rate and minimal foreign borrowing).

5. Another potential option that foreign dollar holders have is to recycle those dollars into US goods & services by purchasing American exports. In practice, this doesn’t seem to be a very popular option, as evidenced by America’s trade deficit.