Think of ‘trade Deficits’ as ‘job-generating, Capital-creating Foreign Investment Surpluses for a Better America’

The BEA released data today on US international transactions for the fourth quarter and for the year 2012.  For all of last year, the US had a current account or “trade” deficit for goods and services of $475 billion, which is the amount that cash outflows of $3.411 trillion from the US for: a) imports of goods and services, b) income payments to foreigners on foreign-owned assets in US (e.g. dividend and interest), and c) unilateral transfers (e.g. foreign aid) exceeded cash inflows of $2.936 trillion into the US for: a) exports of US goods and services abroad and b) income receipts paid to Americans on US-owned assets abroad. The current account deficit of $475 billion was exactly offset (with an adjustment for “statistical discrepancy”) by a capital account or “foreign investment” surplus of $475 billion, which is the amount that cash inflows from the sale of US assets to foreigners exceeded the cash outflows from the sale of foreign assets to Americans.

While most of the media attention focuses on America’s “trade deficit” whenever international transactions are reported by the BEA, a more complete analysis always reveals an offsetting “foreign investment surplus” once capital flows are accounted for,  which always results in a “balance” of our total payments (cash outflows) and receipts (cash inflows) with the rest of the world. What frequently gets overlooked by media reports and hand-wringing politicians is that this outcome is inevitable and guaranteed, because international transactions are calculated using double-entry bookkeeping accounting. Without exception therefore, international cash flows in a given quarter or year HAVE TO BALANCE, and the overall balance of payments has to equal ZERO.

The chart above shows graphically what happened last year and how the balance of payments equaled zero: a) there was a $3.4 trillion cash outflow from the US as American consumers, businesses and governments purchased goods, services and assets from abroad, and as US businesses and governments made income payments to foreigners (e.g. dividends and interest) for investments they previously made in the US, and b) there was a $3.4 trillion cash inflow to the US as foreigners purchased American goods, services and assets, and as foreign businesses and governments made income payments to Americans for assets owned abroad.

Once we account for all international transactions that took place last year, the cash inflows from abroad of $3.4 trillion paid to Americans exactly equaled the $3.4 trillion in cash outflows paid by Americans to foreign recipients. Like in every quarter or year, the positive and negative cash flows or payments perfectly balanced, as required by the double-entry accounting for international transactions, and the “balance of (all) payments” equaled zero, as the chart above shows.

As Dan Griswold wrote in the Washington Times in 2011:

“A trade deficit doesn’t mean that the dollars flowing abroad just disappear. They quickly return to the United States. If they are not used to buy our goods and services to export, they are used to buy American assets — Treasury bills, corporate stock and bonds, real estate and bank deposits.

“In this way, America’s trade deficit is always and almost exactly offset by a foreign investment surplus. The net surplus of foreign investment into the U.S. each year keeps long-term interest rates down, prevents the crowding out of private investment by government borrowing and promotes job creation through direct investment in U.S. factories and businesses.”

Bottom Line: Even though it’s not “newsworthy” and won’t be covered by the media, America’s international transactions were once again balanced last year, just like every quarter and every year, and the “balance of payments” was once again ZERO.

The concern by the media and politicians about America’s “trade deficit” is frequently misguided and meaningless because there really is no overall deficit (or surplus) once we account for all international transactions including capital flows. And as Don Boudreaux commented in 2011, “Another name for ‘US trade deficit’ is ‘US capital-account surplus’ – that is, inflows of investment funds into America that supply (directly or indirectly) financing for more capital creation in America.” And separately, Don reminds us that “To lament an American trade deficit, is to lament the fact that foreigners are investing in America. And that seems very odd.”

Suggestion: To think more clearly about international trade, every time you hear the term “trade deficit” in the media or from a politician, especially when it used negatively to imply America’s economic weakness, just replace it with the term “shovel-ready job-generating and capital-creating foreign investment surplus for a better America.”