Trade deficits

If a country has a trade deficit, then it is reasonable to expect that they (i) also have a current account deficit and (ii) are a net borrower on global markets. Is this a bad thing? Indeed it is typical of rich countries (such as the US and the UK) to import more goods than they export; hence they run current account deficits. But to maintain the balance of payments a current account deficit must result in a capital account surplus. You might hear commentators say the following:

“The US must borrow more than $3 billion per day from foreigners to finance its huge trade deficits.”

But the following is just as true:

“Foreigners must sell the US goods and services worth more than $3 billion per day to finance their huge purchase of US assets.”

People often refer to the “twin deficits” of a budget deficit (when government spending > government revenue) and a trade deficit (when imports > exports). But it is important to realize that:

The main point is that it depends on why there is a current account deficit. In a McKinsey Quarterly article, Jack Hervey and Loula Merkel provide three potential explanations for the US current account deficit.

1. Is it due to a consumption boom, in which case is it sustainable?
2. Is it due to foreign people viewing the US economy to be a safe haven, in which case the extra loanable funds should put downward pressure on interest rates, but may be subject to reversal.
3. Is it due to technological change, and foreign people wanting to invest in the US economy, in which case the higher demand will put upward pressure on interest rates.

They argue that consumption had been falling as a share of GDP, and that industrial materials are a larger share of imports than consumer goods. They also argue that in a large diversified economy such as the US “hot money” is not a realistic concern. Sudden capital withdrawals are much more dangerous for small countries with a less steady flow of capital. And most of the US capital inflows are FDI, large equity stakes and longer-dated bonds. They conclude that the source of the current account deficit is therefore more likely to be due to technological improvements, which is good news –

“with greater investment and productivity, the United States could expect to reap income gains in the future”.

McKinsey Quarterly

So current account deficits aren’t necessarily a problem. For emerging markets this might also be due to the fact that they are making lots of investments and will experience higher future growth as a result. In which case running a current account deficit may be perfectly sensible. However, if an emerging market begins to resemble a safe haven relative to other countries in the region, attracting high portfolio inflows, or if incoming funds are used as a means for increased consumption, rather than investment, there may be concerns. If the current account deficit reflects an underlying indebtedness, then it may well be a problem. But not in and of itself.

In October 2022 there was a widespread concern that the UK was on the verge of a currency “crisis”, which is when a currency loses a lot of value relatively quickly. See this video for my assessment:

In his 2023 book, ‘The crisis of democratic capitalism’, Martin Wolf makes the following points (p. 70-71):

• From 1870-1913 the UK ran a current account surplus of 4.6% on average.
• During this period, most of the net flow of financing went into buying real assets, such as infrastructure and mines in countries such as Argentina, Australia, Canada and the US.
• Between 1997-2007 China’s current account surplus averaged 4%, and Germany’s 3%. China’s surplus was as high as 10% in 2007, and Germany’s was over 8% in 2015, 2016 and 2017.
• This time, the net flow went into debt-fueled consumption, or assets like housing. This has contributed to a more fragile global financial system.