Message to China: Trade "Deficits" Are Quite Beautiful

With word that China's economy fell into the "red" last month thanks to a trade "deficit", business journalists predictably used the information as a straw man to proclaim a looming economic slowdown in this rising nation. The Wall Street Journal's Bob Davis and Aaron Back mused that the number raises "questions about whether the country's economy is tailing off more rapidly than anticipated."

One can only hope that China's economic authorities aren't as misinformed about what drives economic growth as U.S. newspaper reporters are. That's the case because trade "deficits" are an undeniable sign of economic growth and progress.

On this subject, the basics should be covered first. For one, countries do not trade, while individuals do. And as individuals our trade balances, by definition.

It's been repeated numerous times in this column, but bears mention again that I run trade deficits with my landlord, Safeway and American Airlines, among others. My trade deficits are my reward for the trade surpluses I run with my various employers. Ultimately this balances out as a rule, but my long-term desire is to run even larger deficits with all three thanks to increased pay (surpluses) from my employers.

Back to China, as a nation filled with increasingly productive individuals, trade deficits signal much the same. As the Chinese produce more, they naturally import more. To simplify what's already simple, we produce in order to consume. I trade my editing and writing work for all the things I'm not good at such as building a living space, growing food, and air transportation. With the Chinese, they're doing the same. Increased growth will result in more exports, and as a result, more imports.

As for the "deficits", the explanation for them is also simple. Indeed, commensurate with Chinese deficits in trade is a rise in China's capital account; specifically investment inflows into a nation whose businesses are increasingly attractive to investors. China as a country runs a trade deficit due to this capital surplus that is foreign investment; investment a bullish signal for it authoring economic advancement.

Importantly, when Chinese companies "export" shares to eager foreigners, and then import goods with the proceeds of those exports, the imports boost the trade "deficit", while the very real export of shares does not count toward the trade "surplus." What this tells us is that the calculation itself is an accounting abstraction. Trade still balances, or more to the point, one must still export in order to import. The laws of economics haven't been suspended despite the naïve assumptions of economists and business journalists.

In China's case, particularly if it continues to evolve economically, its "deficit" in trade will continue to rise much as the "deficit" in the U.S. has during periods of strong economic growth. Since the ‘80s, Americans have increasingly exported shares in the most promising companies in the world in exchange for goods such as shoes, socks and t-shirts not in their economic interest to produce. This is called progress.

China is at the beginning of a similar, and very positive evolution. Though the U.S. political class irrespective of party affiliation waxes poetic about the "glory days" of the past when the U.S. was a manufacturing economy, the dirty little secret that anyone who's spent time in China is aware of is that the Chinese are more than eager to shift the low-paying manufacturing jobs that theoretically migrated from the U.S. to other, less economically evolved countries. This too is the stuff of economic progress.

Just as American human capital became too valuable to waste on factory jobs, the same is occurring in China. Rather than manufacture shoes, socks and t-shirts for global consumers, Chinese labor is increasingly migrating upward such that individuals there will with greater frequency import prosaic goods so that they have more time to engage in higher value work. This migration will attract investment, thus increasing China's mythical trade "deficit."

What's interesting here is that last month the U.S. trade deficit fell. This will doubtless accrue to the worthless number that is GDP, but it's a negative economic signal for it signaling reduced capital inflows into the U.S. Economic commentators on the right in particular are calling for the U.S. to become an "energy" economy, and it's arguable that one reason for the reduced investment inflow is that more and more human capital stateside is being devoted to finding a commodity - oil - that is already plentiful. As U.S. labor moves backwards chasing this most monetary of illusions, investment will decline too, thus reducing the trade "deficit." This shouldn't please those in possession of sentient minds.

Of course the major driver of the American rush into the past is a weak dollar that creates the false illusion of oil scarcity. The weak dollar on its own is an investment killer given the obvious point that investors, when buying shares in anything, are purchasing future currency income streams; in our case, dollars. Why buy future income streams that monetary authorities are seeking to devalue?

As it applies to China, the aforementioned Journal article featured a comment by a Chinese economist at HSBC who noted that in response to the rising Chinese trade "deficit", "The continuous one-sided appreciation of the yuan [vs. the dollar] has probably come to an end." If so, what a mistake.

That's the case because it's the rising value of the yuan that is surely a factor in the increased investment inflows to the country. Once again, investors are buying future income streams, and if the Chinese seek to mimic devaluationist monetary authorities in the U.S., this will show up in reduced investment, a bearish signal, and reduced trade "deficits", yet another bearish signal.

Here's hoping Chinese economic authorities don't fall captive to the absurd, and wildly discredited view that trade "deficits" are economic negatives. Instead, they should recognize that these accounting abstractions are a signal of rising capital inflows to the country in question; the latter the reward for productive economic activity.