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Demystifying the trade balance

Why a trade balance deficit isn't necessarily a sign of a poor economy

The trade balance is the amount of exports minus imports. While the number generally reported in the media pertains to goods (that is, physical gizmos that are counted as they cross the border), there’s also trade in services such as software, consulting, and tourism. The graph above shows the trade deficit in red (a negative number) for the United States. The current account—that is, the change in asset holdings of the U.S. with the rest of the world—is shown in blue. Indeed, the current account comprises the trade deficit (if we import more, we owe more) plus transfers of income across boundaries. The latter can be important for some developing countries that have a lot of foreign workers sending remittances back to their families. For more-developed economies, dividend and interest incomes are more important.

In the system of National Income and Product Accounts (NIPA, a nation’s economic accounting), a trade deficit automatically implies that the country is saving less than it’s investing. Another way to understand this is that the rest of the world is investing in that country, thereby contributing to its production capacity. This accounting pertains to the capital account, which is always the counterpart to the current account: Current account plus capital account always equals zero, which is quite apparent in the graph below.

Is it bad to have a trade account deficit? If this means that your economy is booming and local production cannot keep up with demand, then no. If it implies that there is a current account deficit and, hence, foreigners are investing in your country, then also no. If this means that you can have more investment without having to save more, because the rest of the world is picking up the slack, no again. If you are worried that in the future dividends will flow abroad, then yes. But that will happen only if your economy is in good shape in the first place and will be able to afford paying such dividends.

How these graphs were created: For both graphs, look for and the first series to the graph; use the “Edit Graph” tab to add the second line; then apply a formula to adjust the units so that both lines match. Note that the trade balance needs to be multiplied by 12, as it’s expressed in monthly numbers.

Suggested by Christian Zimmermann.

View on FRED, series used in this post: BOPGSTB, NETFI, RWLBCAQ027S

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