On economic matters, Trump gets things wrong.  He has a few good instincts as far as reducing regulations and reducing some taxes, but after that he lacks a basic understanding.  With many politicians, you wonder if they are just lying in order to gain power and influence.  But with Trump, you really get the feeling that he just doesn’t understand economics.

One of the issues tied to Trump’s tariffs is the trade deficit.  Trump says that trade is not fair.  He says that the United States is getting ripped off with a huge trade deficit, and he is trying to correct that.  He’s also going to find out, if he hasn’t started to realize it already, that it isn’t easy to turn around the trade deficit.  And if you do solve this imaginary problem, you probably just created a whole set of new problems that aren’t imaginary.

There isn’t really such a thing as a trade deficit if the trade is done voluntarily.  There is stealing.  If one country invades another country and takes some of its resources, then perhaps you could say that this is a trade deficit. But that’s not really what Trump is talking about.

The main reason that the United States runs this so-called trade deficit is because it is an attractive place for investors.  A good example is China selling goods to the United States.  But the Chinese often don’t get goods in return. The exchange might be in the form of services.  Or the exchange might be in the form of investments.

If there were any trade deficit at all, it would be other countries getting the short end of the stick.  They are manufacturing goods and sending them to the United States.  They are often not getting any hard goods in return.  They are getting the equivalent of certificates in investments that may or may not be returned in full.

One of the main things bought by the Chinese and Japanese are U.S. government Treasury bills and bonds.  In other words, they are purchasing U.S. government debt.  So the Chinese will manufacture goods and send them to the United States and receive a bunch of IOUs from the government.  And Trump is complaining about this?

This is actually the one area where trade deficits do matter in the long run.  When these foreign central banks accumulate U.S. government debt, it allows the U.S. government to sustain its reckless spending for longer with cheaper interest rates.  So in this sense, it hurts us.  But that is a problem of spending and debt.  It is not caused by the trade deficit.  The trade deficit is just a reflection of the spending and debt.

But Trump isn’t telling foreign central banks not to buy U.S. debt, let alone actually sell it. He is a low interest rate guy.

Other than the national debt, the trade deficit is basically irrelevant.  It is mostly the workings of the marketplace given the circumstances.  Sure, if the Chinese economy were freer, then maybe the Chinese would invest more of their capital at home.  But the fact that their capital flows to the U.S. does not harm the U.S. economy (other than the government debt as discussed above, which is the fault of the U.S. government).

Let’s say you live on an island with 99 other people.  A foreigner comes in and offers to trade with you.  He will give you some food and luxury items in exchange for a small hut on the island.  You agree.  He decides to come to your island for two weeks out of the year and live in the hut.  As long as he is peaceful, there should be no problem.  This could be considered a trade deficit for the 100 people on your island though because the hut is on the island.

Maybe the foreigner comes to your island and offers to give you food, and in exchange you will give him food five years from now.  Again, this is a trade deficit.

Maybe the foreigner comes to your island and offers to give you food in exchange for one hour of consulting on how to survive on a small island.  You provide your services and get the food.  Although you gave him a service, it was not actual hard goods.  Therefore, you have a trade deficit.

You can start to see how absurd this whole thing is.  Yet there are economists who worry about the trade deficit, and Trump worries about the trade deficit.  It isn’t really a deficit if it is voluntary trade.  The trade just involves different types of goods and services.

We all run trade deficits at a personal level.  If you go to the store and buy a pair of shoes, then you are running a trade deficit with the store.  But the owner of the shoe store will take the money and run a deficit with someone else.  This is how it works. It doesn’t change much just because there are national borders involved.  The only difference is the exchange in currency.

The trade deficit can be a reflection of certain things.  As mentioned above, it is probably higher because of the overspending and debt issued by the U.S. government.  But then it is just a symptom of the problem and not the problem itself.  So if Trump really wants to reduce the trade deficit, then drastically cut spending and allow interest rates to rise.  Unfortunately, I don’t think he is going to take this position.