Trade Deficits & Trade Imbalances – Completely Misunderstood

Part of How Money Works – FAQ

The Two Most Misunderstood and Misused Economic Terms? In my opinion, it has to be the terms: a) “trade deficit” and b) “trade imbalance,” because those two terms are almost always used to imply incorrectly something negative about the US economy, when in fact there really are no trade “deficits” or “imbalances” once we account for all international transactions for goods, services and financial assets (see chart above).

Formula: Current Account + Capital Account = 0 = Balance of Payments.

Therefore, whenever you hear somebody talk about the trade deficit or a trade imbalance, it’s almost guaranteed that you’ll hear nothing about the foreign investment inflow that offsets any current account deficit, or the fact that international trade always balances. Part of the problem is that the term “deficit” automatically implies something negative and “surplus” implies something positive, when in fact those terms should be neutral and should not automatically carry any positive or negative connotation.

Source: Friday afternoon links • AEI