Government leaders have, for centuries, bemoaned the imagined ills of trade deficits. Kings of ancient yore endeavored to achieve surpluses to fund their wars. Dictators of all stripes have carefully sheltered their economies from foreign goods. Because of this perilous legacy, a country running a trade surplus is today said by economists to be running a “favorable balance of trade”.

A good friend and a great economist, Richard M. Salsman (H.C.Wainwright & Co.) reminds us of the inherent flaws in the mercantilist “favorable balance of trade” doctrine. He recently shared some enlightening research clearly illustrating that trade deficits are positive for an economy and its financial markets. Trade deficits, by definition, are offset by net investment inflows; Net inflows suggest that foreigners are investing more in an economy than locals alone could. Net inflows mean locals receive more goods from abroad, thereby enhancing their standard of living. As such, a “trade surplus” could more accurately be called an “Investment Deficit”.

Salsman’s own historical research backs up his assertions. In the nineteenth century, a period characterized by rapid economic growth and development, the United States experienced many more years of trade deficits than surpluses. The promising US economy typically attracted “investment surpluses” from around the world. Since World War II, the US has run trade surpluses about half of the time. On average, US stocks perform better during trade deficit years (15.3%) than in trade surplus years (13.3%), and performed best in years just prior to rising trade deficits (17.8%). Industrial production growth and employment are stronger during trade deficit (i.e., “investment surplus”) years. Contrary to popular opinion (including those of the vast majority of economists and politicians) rising trade deficits represent the best possible trade condition for markets.

Mr. Salsman includes one huge caveat in his report which is worthy of note. Due to nearly universal aversion to trade deficits, politicians and monetary officials almost always intervene to stop them. Initial attempts generally involve erecting trade barriers. But eventually even more damaging policies, like currency devaluation, are implemented. Such attempts are damaging to both investors and the economy, as historically, years of narrowing trade deficits are characterized by stagnant growth, rising joblessness, and poor stock-market returns. Considering the US’s large trade deficit, the looming political threat of a “weak dollar” policy has perhaps the greatest chance of bringing America’s current economic expansion to an untimely end.

The IMF, the nemesis of sound economics, almost always seeks to drive countries into trade surpluses. IMF officials are seemingly on the constant lookout for trade deficits. When they spot targets on their computer screens, they will immediately deploy a team of experts to “solve” the “problem”. Government officials, typically irrationally biased against trade deficits to begin with, generally embrace any proposal to drive out “excess” foreign investment. The deadly plan typically includes currency devaluation coupled with higher taxes, making it nearly impossible for locals to afford imported foreign goods. In general, the plan “works” if you call lower standards of living in return for trade surpluses “working”.

There are a number of countries around the world that have consistently generated large trade surpluses over the past five years: Japan, Germany, France, and Saudi Arabia. Countries that restructure their economies to allow a favorable inflow of both goods and investment should see their wealth rise and trade surplus fall. In emerging markets, Russia and China are both experiencing rising trade surpluses. Despite so called “positive trade balances” each of these countries is struggling to support economic growth. All of these countries are faced with the opportunity to learn that when it comes to trade, it is NOT better to give than to receive. As an investor, don’t let growing trade deficits or falling trade surpluses scare you away. Unless you see the IMF and dense government officials scheming to reverse them

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Andrew West

Andrew West is a Contributing Economics Editor for Capitalism Magazine. In 1997 he received the Chartered Financial Analyst designation from the Association for Investment Management and Research.