Commentary: Trade deficits will not make the United States poor.

Trump's view of the trade deficit is based on two fundamental misconceptions. (Synopsis: Foreign media revealed that Musk "privately lobbied Trump" to withdraw tariffs but failed, and the White House trade adviser: brain problems) (Background supplement: Trump threatens China: If the 34% retaliatory tariff is not withdrawn today, the United States will increase the weight to 50%! I don't really think you can beat Trump's tariff policy by rationally debating or explaining economic theory. I mean, how do you argue with something like that? I've embraced the idea that Americans will only generally realize that broad tariffs are bad by experiencing the negative consequences of them firsthand — that is, touching the so-called hot stove. Fortunately, I think Americans might wake up soon: But this is an economics blog anyway, so while I don't expect much political return, I guess I should explain why trade deficits don't make a country poor (although that doesn't mean they're okay). Trump's Erroneous View of the Trade Deficit Trump's advisers and entourage believe that the trade deficit means that the United States is "blackmailed" by foreign countries. As I explained in yesterday's post, that's why Trump set the tariffs at a level he believes can eliminate the U.S. trade deficit with every country. Trump's view of the trade deficit is based on two fundamental misconceptions. The first is a simple accounting error. Trump's advisers looked at the formula for gross domestic product (GDP) and noticed that imports were subtracted from GDP. They don't understand that this is because imports are also added to consumption and investment, so in the end they must be subtracted to remove them from the numbers. The fact is that imports do not have any effect on GDP. Trump's second misconception is based on the idea that imports will be replaced 1 to 1 by domestic production — that is, if you block the U.S. from importing one washing machine, an American company will produce one more washing machine. This is certainly one possible outcome, but not the only one. American consumers may simply use one less washing machine, which will make everyone poor. In fact, Trump and his team may not even realize that these are two different misconceptions. They may think that their false beliefs about accounting (i.e. imports reduce GDP) naturally stem from their false beliefs about import substitution. These two errors reinforce each other. In short, because Trump misunderstands the trade deficit in both ways, he believes that when the United States has a trade deficit with a country, that country is blackmailing them. He argues that imports are forcing the U.S. to produce less, thereby reducing U.S. GDP — essentially stealing U.S. production. Therefore, he sees the trade deficit as a measure of how much the United States has been stolen. But that's not how the trade deficit works at all. A trade deficit is like buying something with a credit card Let's say you imported a washing machine from a Chinese named Ruimin. Why did Ruimin give you that washing machine? There is no such thing as a free lunch in the world. Basically, you can pay for that washing machine in two ways. The first way is to give Ruimin what he wants — like 50 interesting books (assuming Ruimin is known for his love of reading). The second way is to write an IOU to Ruimin. The first scenario is called trade balance. You get a washing machine, Ruimin gets 50 books. There is no trade deficit or surplus. Another scenario is a trade imbalance. In this case, you are not giving Ruimin 50 books, but giving him an American Treasury bond. A bond is an IOU. In this case, you contribute to the U.S. trade deficit with China. A real good or service — a washing machine — is shipped from China to the U.S. in return with just a piece of paper (or actually a number in a spreadsheet). When you hear economists talk about trade, you probably hear them talk about the "current account" and the "capital account." The current account is basically just a net flow of real goods and services, while the capital account is basically just a net flow of IOUs. If you give Ruimin an IOU in exchange for a washing machine, it means that you are contributing to the current account deficit of the United States, as well as to its capital account surplus. Both of these things simply mean "paying something to foreigners with an IOU". Now you can see why a trade deficit is like buying something with a credit card. When I bought a washing machine from my target with a credit card, I wrote an IOU, and I got something tangible in return. Does buying a washing machine from a target with a credit card mean that the target person blackmailed you? No. Will buying a washing machine from a target with a credit card make you poor? It won't. You have less money now, but more stuff. By the same token, a trade deficit means the U.S. has less money and more stuff. This does not mean that the United States has become poor or blackmailed by foreigners. Asking whether a trade deficit is good or bad is like asking whether it is good or bad to buy something with borrowed money. The answer is obviously "depending on whether the purchase is worth it." One thing to remember is that not all purchases are for consumption – many are actually productive investments. If a U.S. factory buys a CNC machine from Japan for $100,000, and the Japanese toolmaker simply deposits that money in U.S. Treasuries, it adds to the U.S. trade deficit. But if the U.S. factory uses the tool to make and sell $500,000 worth of auto parts, it makes — and so does the U.S. This is what South Korea did during its rapid industrialization. Around 1980, as well as in the early 1990s, South Korea had a trade deficit: During this period, South Korea was investing heavily in the industrial economy: By the way, in the late 70s and early 80s, South Korea, while running a trade deficit, was also increasing exports - not only in dollar terms, but also as a percentage of its GDP: Remember, exports increase GDP, while imports do not subtract from GDP. Therefore, even if South Korea has a large trade deficit, trade will add more and more revenue to South Korea's GDP every year. A supporter of Make America Great Again (MAGA) has a hard time comprehending this fact. But in any case, South Korea's trade deficit at that time might have been worth it, because importing capital goods (machinery, etc.) helped them industrialize faster than they could make all those capital goods themselves. They simply bought machines and immediately used them to make cars, TVs and other useful things, most of which they sold at a profit to the rest of the world. In fact, the United States has done so to some extent. When we think of the U.S. trade deficit, we usually think of consumer goods — cheap Chinese TVs and so on. But the United States also imports significant amounts of capital goods with which American companies produce and sell products. The United States did more in the 1990s, when we had a trade deficit, but there was also an investment and export boom. But be careful: "Investing with the trade deficit" does not mean "the trade deficit is good." For example, if a company imports a lot of capital goods but has a low return on investment, that can be a bad thing. What if the trade deficit is used for consumption? Is that good or bad? So what happens when you use the trade deficit to buy consumer goods — those cheap Chinese TVs and Canadian-made cars and so on? Today, consumer goods account for most of the U.S. trade deficit. Is this trade deficit good or bad? In this case, we have to decide whether "buy now, pay later" is good or bad. Remember, a trade deficit is like buying something with a credit card. When the United States imports China...