Twin deficits will kill us?
This is my last in a series of articles, for the time being, on debt and deficits. I've already written about the budget deficit and the national debt, and I hope you now have some better perspective on those issues, so that the next time you hear the typical one-sided commentary, you'll be better equipped to analyze the arguments. Today, I'd like to discuss the trade deficit.

The trade deficit is often alluded to as being one half of America's "twin deficits," the other half being the budget deficit. Like the budget deficit and national debt, the trade deficit is characterized in much the same fashion, in that all of the attention is focused on the negative balance on one side of the ledger, with little mention of the positive inflows on the other side.

Let's take a look at the numbers. Last year, the United States exported $1.75 trillion worth of goods and services, an amount that made us the world's largest exporting nation. (Who says we don't export!) However, we also imported $2.46 trillion worth of goods and services from abroad, giving us a trade deficit of $710 billion.

All of a sudden, things are not looking so good, right?


That's because we haven't examined the other side of the balance sheet yet.

Reality check
Although we had a $710 billion outflow because of our big import tab, foreigners pumped a whopping $1.2 trillion in investment into our economy. They were snapping up Treasury bonds, stocks, and non-governmental bonds, and putting them into other forms of direct investment. The $1.2 trillion figure more than covered the $710 billion trade deficit, but as usual, the media and the so-called "experts" focused only on the red ink and not the good stuff happening on the financial side.

Yes, the media and the "experts" did talk about those capital inflows, but they totally mischaracterized them by saying that it was simply a case of foreigners "financing" us, and that it was only thanks to their largesse and generosity that we can continue with our profligate ways.


Nobody forces foreigners to invest in America. It's a free, global economy, and they can invest their money anywhere they want. But they put it here because the U.S. economy is the world's engine of growth. Foreign nations -- particularly Asian nations -- have been growing their economies and creating jobs for their citizens by selling products to America. In some cases, this has been going on for decades. In fact, some nations have become so dependent on this form of export-driven growth that they have engaged in all forms of protectionism, including impediments to trade and the costly manipulation of their currencies to maintain a competitive advantage.

At this point, you may be thinking, "Well, haven't they beaten us at the game, then? After all, Mike, you just said they've secured a competitive advantage."

The answer is no -- they haven't beaten us. All they've done is gain an advantage in exports, but it comes at a tremendous cost to their citizens' standard of living. Because to gain that advantage, they've had to divert vast amounts of the money they've earned toward protecting their markets, subsidizing certain industries at the exclusion of others, and keeping their currencies weak relative to the dollar, thereby reducing or suppressing their workers' purchasing power. That's not only inefficient; it's also unsustainable in the long term because it leads to an ever-widening gap between their living standards and those countries where economies are open, as in the case of America. Another way to state it is that imports are a benefit, while exports are a cost.

The average Joe's trade deficit
That may sound counterintuitive, but let me illustrate by way of example on the micro level.

Think about how any person operates in his or her daily life. Almost all of the things any person needs to live and function must be bought from some other person or entity that makes or supplies those products and services.

For example, you buy food from the grocery store and you buy clothing from the clothing store. Your electricity comes from the electric company, your telephone service from the telephone company. When you get sick, you go to a doctor, and you attend school to get an education. If you get in trouble with the law, you'd better go and see a lawyer. If you want to be entertained, you go to the movies, and to get to the theater, you'll probably have to hop in your car, which you bought from a manufacturer. And you're going to have to live someplace, so you'll need a homebuilder to build you a home -- or an apartment building owner can provide you with a nice apartment.

You're probably saying, "Yeah, so? What's the point?

The point is, YOU are running a trade deficit with all of the providers of goods and services I just mentioned -- along with many more, most likely. You buy more from them than you sell to them. In fact, it's a good bet that you buy everything you need from your vendors and sell them nothing, so your deficit with them is relatively important. I will even go one step further and say that you couldn't even live without that deficit unless you can grow your own food, generate your own electricity, provide your own communications services, have double degrees as a physician and attorney, are a filmmaker who owns a movie theater, can build your own car and home, and so on. Having that deficit sustains you.

I know what you're thinking. "Mike, c'mon, we need all those things to live, and it's obvious we can't make or provide them ourselves. However, that's not the case with the U.S. trade deficit. After all, America can produce a lot of the things we import, but we don't. That's the problem."

How wealth is created
That argument may sound correct, but it is false. Both situations -- the one on the micro level and the one on the macro level -- are entirely the same. Any one of us could choose to live a simpler life, perhaps on a farm somewhere without all of the fancy cell phones and BMWs and iPods and designer jeans and shoes and flat-screen TVs. We could build a little cabin and read books by candlelight for entertainment. But we don't, because for most of us, it would represent a major reduction in our standard of living. (No offense to folks who do live on farms.)

There's one very simple reason we buy the goods and services we need from vendors and suppliers, and that's because it's easier and more efficient, and it allows us to focus on what we really do best -- going to our jobs and earning a living. That's called productivity, and that's how wealth is created!

The deficit in trade that we have as individuals with our vendors and suppliers allows us to work and earn more than enough income to cover that deficit. The amount left over each month after we pay our bills, we call savings. For a country, it's called the net reserve position. And the whole thing, international capital flows minus trade position, is called the balance of payments. And America does not have a negative balance of payments; it only has a deficit in trade. So cheer up and let the foreigners do the worrying, because they need us more than we need them.

For related articles:

Trying to wrap your head around the world of finance? The Fool's new personal-finance service, Motley Fool GreenLight , may be just what you're looking for . Try it out for free.

Mike Norman is the founder and publisher of the Economic Contrarian Update and is a Fox News business contributor. He also is a radio show host at BizRadio Network.