What they don't tell you about shrinking trade deficits

By Kevin Price

The dreaded "trade deficit" is shrinking – let's celebrate! In spite of the fact that we are seeing more robust employment numbers (although also vacillating), there is no reason to add the shrinking trade deficit as a good thing, in spite of the political rhetoric on all sides. Rather, it could be a harbinger of an economic reality that few will want to embrace.

Yet, we are seeing the media is proudly promoting the fact that the US has a shrinking trade deficit.

The balance of trade – the amount of goods imported versus goods exported – has been a tool used by those who are shallow in their economic knowledge and deep in their fear of competition. We are told by many politicians that trade deficits (importing more than we export) is a "terrible" thing and demonstrates an economy in decline. As a result of decades of trade deficits, the US is a "debtor" nation, we are told.

So the recent news stories should be "good news," that the trade gap continues to narrow. This narrowing is because the amount of goods we are importing each year is actually shrinking. This means that consumer demand is going down (not just for imports, but in general, because consumers are not really that discriminating). In a recent interview I had on my radio program with economic historian Brian Domitrovic, he indicated that when countries have trade surpluses there is a decrease interest among other nations when it comes to doing business with them. He pointed to the situation of the US and Japan in the 1980s was a perfect example of such. While the US bought Japanese goods in massive volumes during the 1980s, that country then used those US dollars to buy Real Estate throughout the country. How was that harmful to the US?

When the economy is weak, we can't afford to buy. Our trade deficit shrinks with our spending power.

In 1928 Republican Herbert Hoover was running for President of the United States against Democrat Al Smith of New York. Hoover, the Secretary of Commerce under one of the most successful Presidents in US history, was running against a very popular governor. It was easy for Hoover to defend the record of the President he served, Calvin Coolidge, as virtually every indicator pointed to an administration noted for its prosperity. "A chicken in every pot and a car in every garage" was a message that rang true to most voters.

During the 20s, Coolidge and his allies took a tax rate that was as high as 70 percent under their predecessor and lowered the top rate to a low of 5 percent. Coolidge opened economic trade with countries and unleashed a level of prosperity we had not seen in generations. The number of people who made six digits (a very high income in the 1920s) increased four fold. Inflation was less than 2 percent and unemployment was at a comparable amount. They called it the "Roaring Twenties" for a reason.

In spite all the glitter, there were signs of "rust" for those who cannot look beyond the obvious. That was the trade deficit that grew rapidly during the Coolidge administration. This area fell under the Secretary of Commerce and Hoover was taunted by his opponent throughout the race as the man who oversaw this area of "decline." Finally Hoover got on the protectionist bandwagon and told voters that if Smith or he were elected, there would be quotas and tariffs placed on trade. Hoover won and by the Fall of 1929, he was sticking to his promises and pursuing protectionism in the form of the Smoot-Hawley Tariff Act.

That law did exactly what it intended to do – slash the import of goods. Within a few years, the US had its first trade surplus in decades and also one of the highest unemployment rates in history. The stock market crash that proceeded the Depression was fueled by this trade protectionism. Wall Street knew that, if we penalized imports, foreign countries would retaliate. That led to the market crash because investors knew that the value of goods would decline as the trade markets would shrink.

The high unemployment rate was associated with the trade surplus for a very simple reason. We imported more goods than we exported because our buying power had declined dramatically. Throughout our nation's history over the last century, our periods of highest prosperity were accompanied by eras of trade deficits. Meanwhile, trade surpluses accompanied economic decline. In our prosperity we were buying more, from everywhere.

Today, the trade deficit's shrinking is a sign of systemic weakness. Our national buying power is in decline. Trade deficits continue to do what they have done for centuries – indicate flaws in an national economy and not a nation that is economically robust.

© Kevin Price