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Home | Blog | Which is Worse — A Trade Surplus or a Trade Deficit?

Which is Worse — A Trade Surplus or a Trade Deficit?

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Tags Financial MarketsGlobal EconomyMoney and BanksPolitical Theory

Germany is currently the country with the largest trade surplus, and many Germans think that this is a good thing. In the United States, the situation is the reverse. The US has the world’s largest trade deficit. It amounts to USD 502.25 billion for 2016.

A country’s trade balance is equal to the difference between a country’s national savings and its gross investment. Savings reflect the difference between income and consumption. Thus, a country with a surplus consumes or invests too little given its income. That is the case with Germany. In America, it is the other way around.

How is this disparity possible? It is possible because the dollar and the euro are both fiat monies. Different from the gold standard, countries can now get along with persistent trade imbalances. These trade imbalances, in turn, permit grave domestic discrepancies among income, consumption, and investment.

Germany is a pathological case because its trade surplus results from both too little investment and too little consumption. Too little investment means that the capital stock does not rise as much as it could. This, in turn, will lead to lower future income as otherwise could be the case. This means that while Germans consume now less than they actually could, in the future they will have to consume less because they must.

It seems paradoxical but it is not: while Germany has a huge trade surplus — or for that matter the more comprehensive current account balance — and the United States has a huge trade deficit, each country invests too little. In both the US and Germany, the gross investment rate is very low (table 1).

Table 1.

United States and Germany: savings, investment, consumption, and current account average in percent of gross domestic product (GDP) for 2006-2016:

 

Gross domestic savings

Gross fixed capital formation

Final consumption expenditure

Current account balance

United States

14

17.5

86

-3.2

Germany

24

18.0

75

6.8

 

Source: Trading Economics and own calculations (www.tradingeconomcis.com)

The lack of capital formation undermines productivity and future economic growth in both countries. In the United States, the trade deficit is the result of the overvalued U.S. dollar, which in turn comes from its role as the global reserve currency. Americans consume and invest less than they should because they can afford to do so because of the role of the dollar.

Why should a country with either a surplus or deficit change course? Because persistent trade imbalances are unsustainable. They lead to the accumulation of foreign debt at the deficit country and to increasing foreign assets in the surplus country. One country’s surplus is another country’s deficit. Similarly, one country’s foreign asset position is another country’s foreign debt.

With a foreign debt (net foreign investment position) of eight trillion in mid-2016 (Figure 1), the United States is approaching a critical level.

Figure 1.

If debt accumulation should go on, the credit-worthiness of the United States will eventually crumble and consequently its currency will crash. A soft depreciation of the dollar in time is surely better than an abrupt currency collapse in the future.

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President Trump wants to have more jobs at home and calls for the elimination of the trade deficit. A first step to accomplish this would be to do away with the role of the US dollar as the leading reserve currency.

Putting an end to the policies of the previous American governments to bomb and sanction these oil exporters that wish to use a currency other than the greenback would automatically bring about the demise of the US-dollar. The elimination of America’s trade deficit and the end of foreign debt accumulation would follow. Doing away with fiat money would then be the next big step towards a sound economy. 

Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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