Part 1 addressed tariffs in general and why they are for the most part shortsighted. In this post I’ll briefly address Trump’s misconceptions about trade.

The first fallacy is his apparent belief that bilateral trade with every country must be even. That is, if we run a trade deficit with a country like China, then to Trump it means they are taking advantage of us and we are “losers.” This is simply ludicrous. To paraphrase Greg Mankiw in the New York Times, if you buy products at a store like Target, would you expect Target to buy the same dollar amount of goods from you? Of course not! In fact, you run a personal trade deficit at every store at which you choose to shop. How do you keep your personal trade balanced (and avoid bankruptcy)? By providing your own personal services (work) to a company (your employer or your own business) which pays you for it. This is the equivalent of having a trade surplus with that company. When you add that surplus to your trade deficits from your favorite stores, you end up with a positive balance of trade assuming you are earning more than you are spending.

Trade between countries works in a similar manner. If the U.S. has a trade deficit with China, it’s simply because China has more goods and services desired by Americans than there are U.S. goods and services preferred by Chinese. There are other countries that purchase more from the U.S. than they export (i.e. with whom the U.S. runs a trade surplus). In general, bilateral trade will almost never be deficit-free. What’s important is to maintain a positive trade balance in the aggregate.

Tariffs do play a part in artificially manipulating trade, as discussed in Part 1. Legitimate complaints with China, beyond its protective tariffs, are its trade restrictions for the purpose of acquiring intellectual property and its lack of piracy enforcement. But from a purely numerical standpoint we are unlikely to ever have a zero balance of trade with them or with any individual country.

And yet, the U.S. has been running current account trade deficits since World War II. For some countries this would be highly problematic, but the U.S. has an advantage due to the dollar’s status as the world’s reserve currency. When France purchases oil from Saudi Arabia, for example, they use U.S. dollars as payment. This is possible only because the rest of the world accumulates dollars, providing us the equivalent of a multi-billion dollar interest-free loan. These capital inflows from our trading partners allow U.S. policymakers more freedom than those in other countries to focus on domestic goals such as improving our standard of living. But there is a downside: not only does the U.S. debt level keep increasing, but particularly during periods of stress, the value of the U.S. dollar tends to soar as the safe-haven currency, making exports more expensive and concomitantly putting more profit pressure on U.S. companies.

In short, the effects of trade wars are complex and are unlikely to result in the simplistic benefits touted by Trump. Perhaps most ironically, he lambasts trade deficits as detrimental to our economy, yet at the same time promotes new tax rules that, according to the Congressional Budget Office, will raise the national debt by $1.5 trillion over the next ten years. One can only hope that this president will take the time to listen to business leaders and economists who presumably have a better understanding of the possible outcomes and consequences.