A trade tutorial for Trump

COMMENT

President Donald Trump has declared that the United States’ $500-billion trade deficit with China means the US is “down” $500-billion.

He apparently thinks that trade surpluses and deficits amount to profit and loss statements for countries. He could not be more wrong.

Let’s say that a developer erecting an apartment building in New York City purchases $50-million worth of construction material from China, and spends another $50-million on local services. If the developer then sells the building to American buyers for $110-million, he has made a profit of $10-million.

The venture, it seems clear, made good business and economic sense.

The $50-million spent on Chinese imports certainly would not be considered a loss. Yet that is precisely what Trump’s logic implies. Worse, Trump would demand that, to “even things out”, China purchase $50-million of US products — or face tariffs that make it more expensive for future US developers to purchase construction materials from China.

If, for example, the new tariffs totalled 25% of the “loss”, or $12.5-million, the same project’s total cost would jump to $112.5-million. A $110-million sale would then imply a $2.5-million loss, rather than a $10-million profit. A smart developer would work this out in advance, and potentially scrap the project (unless they could find local suppliers to offer a better deal). That would hurt the entire economy, especially if the tariffs affected a large number of investments, as Trump’s steel and aluminium tariffs will.

For the sake of any who share Trump’s flawed logic, the point can be clarified further.

The $50-million the developer spent in China was exchanged for $50-million worth of goods. That makes it an equal and balanced transaction. Demanding that China purchase $50-million worth of US goods would have no effect; it would simply produce another equal and balanced transaction.

To use the language of deficits and surpluses that so trips up Trump, the US might have a “currency deficit” of $50-million following the developer’s transaction, but it would also have a “goods surplus” worth $50-million. The fact that the US dollar is the main global reserve currency makes this all the more agreeable, because the developer was able to pay for those Chinese materials directly using dollars.

If the dollar were not the main global reserve currency, the US government would have more reason to be concerned about the currency deficit from trade, because the developer would then be forced to purchase $50-million worth of another currency — say, Japanese yen — to complete the transaction. This could raise fears that US reserves of yen would become depleted, and that purchasing more would devalue the US dollar. In that case, the US government might encourage more foreign purchases of US goods to “balance” the currency deficit.

But that is not the situation Trump faces. Instead, the Chinese end up with $50-million in their bank account, in the form of US dollars that they can then use to purchase US government bonds, thereby financing the US budget deficit (as they have long been doing).

They can also use those dollars to buy US stocks, helping American businesses and the overall economy — or to buy products from third countries, boosting global trade.

In an open economy, businesses are free to buy and sell products in whatever markets they can access. In our example, the Chinese neither forced nor duped the developer to purchase their construction material. Instead, a willing buyer chose to engage with a willing seller on the basis of a straightforward economic calculation.

The developer most likely chose not to purchase the materials from US suppliers because the cost would have been higher, resulting in lower profits — or even a loss.

If a government forces a business to make what is clearly an economically suboptimal choice — say, by using tariffs — the rest of the economy will suffer.

So if the US runs an $800-billion annual trade deficit, it is simply because US businesses and consumers choose to purchase $800-billion more in goods from the world than the world has purchased from the US, owing to some advantage, such as lower prices than domestically produced equivalents. In the case of a business, this means a larger profit margin. In the case of consumers, it means more money to spend on other goods and services. Either way, the US economy benefits.

So does the global economy, because that $800-billion of surplus US currency can be used productively by the world to purchase financial or real assets. This does not hurt the US — a unique advantage enjoyed by the reserve currency-issuing country — and boosts global economic dynamism and growth.

From a policy perspective, all the US should be concerned about is ensuring that inflation does not creep in because of an excessive supply of US currency. That is not up to the Trump administration but to the US Federal Reserve, which has a strong record on this front: despite a $14-trillion aggregate currency deficit on trade since 1990, the Fed has managed to keep inflation low.

As for Trump — or at least his advisers — the need for a better understanding of how global trade actually works has become glaringly obvious. Barring that, his administration’s reckless interventions are likely to continue, or even escalate, causing severe damage to the US and the global economy. — © Project Syndicate

Asad Jamal is the founder and chairman of ePlanet Capital

These are unprecedented times, and the role of media to tell and record the story of South Africa as it develops is more important than ever. But it comes at a cost. Advertisers are cancelling campaigns, and our live events have come to an abrupt halt. Our income has been slashed.

The Mail & Guardian is a proud news publisher with roots stretching back 35 years. We’ve survived thanks to the support of our readers, we will need you to help us get through this.

To help us ensure another 35 future years of fiercely independent journalism, please subscribe.

Advertisting

‘Frustrated’ police resort to force

Regulation uncertainty leaves slap-happy police and soldiers to decide when people should or shouldn’t be allowed on the streets

Mail & Guardian needs your help

Our job is to help give you the information we all need to participate in building this country, while holding those in power to account. But now the power to help us keep doing that is in your hands

Press Releases

New energy mix on the cards

REI4P already has and will continue to yield thousands of employment opportunities

The online value of executive education in a Covid-19 world

Executive education courses further develop the skills of leaders in the workplace

Sisa Ntshona urges everyone to stay home, and consider travelling later

Sisa Ntshona has urged everyone to limit their movements in line with government’s request

SAB Zenzele’s special AGM postponed until further notice

An arrangement has been announced for shareholders and retailers to receive a 77.5% cash payout

20th Edition of the National Teaching Awards

Teachers are seldom recognised but they are indispensable to the country's education system

Awards affirm the vital work that teachers do

Government is committed to empowering South Africa’s teachers with skills, knowledge and techniques for a changing world

SAB Zenzele special AGM rescheduled to March 25 2020

New voting arrangements are being made to safeguard the health of shareholders