Reply To: Trade deficit


Here is how I understand it (and I’m sure Dr. Herbener will correct me):

International trade is made of two parts: the current account and the capital account. The current account consists of goods and services, the capital account consists of capital. A current account deficit (which the US has) implies a capital account surplus.

Treasuries are not traded directly for imports, but government deficits can contribute to the current account deficit.

When the government has fiscal deficits, it sells treasury bonds. Many of these bonds are bought by foreigners and foreign governments. These governments pay for these treasuries with US dollars. Where do they get these dollars? They obtain them by selling goods and services to Americans (or tax those who do). Thus, instead of buying American goods or services, they buy US treasuries, which goes to funding government employees, transfer payments, wars, etc. (and some of it then might be spent on imports).

In national accounting terms, there is total savings (TS) = private savings + public saving. In the US, there is no public saving; it is negative, which decreases TS. The demand for loanable funds (which is supplied by total savings) cannot be fully met by domestic saving. This tends to lead to higher interest rates and foreigners investing their savings in the US (of course, the Fed affects this whole scenario as well). Ceteris peribis, foreigners investing their savings in the US will increase the capital account surplus, and thus increase the current account deficit.