China and U.S.: There Really Is NO Trade Imbalance

Click to enlarge.

Don Boudreaux picks a nit about "trade imbalances" with Jeremy Warner, who writes an otherwise excellent article in the London Telegraph about Paul Krugman's misguided suggestion of a 25% surcharge tax on China's imports American consumers and U.S. companies who buy goods from China for their low prices and great value:

"You write as if the alleged trade imbalances between the U.S. and China are real. They are not. The Chinese sell Americans goods; we pay with dollars; the Chinese then use many of these dollars to buy IOUs issued by Uncle Sam. Although the result is a measured U.S. current-account deficit with China, there’s no more any economically meaningful “imbalance” in such a result than there would be if, say, Texans lent a lot more of their dollars to Uncle Sam.

Talk of imbalances in trade diverts attention from the real problem: Uncle Sam’s gargantuan debt. That fast-accumulating debt is a huge problem. It is caused, though, not by trade with China but, rather, by Washington’s lack of fiscal discipline. Unless you believe that protectionism (and only protectionism) would induce Congress to be more fiscally disciplined, you should avoid all talk of imbalances in trade and instead talk of imbalances in political institutions that encourage politicians to give disproportionate weight to the demands of current voters and to ignore the resulting ill-consequences that will curse future generations."

MP: The graph above illustrates Don's point that there is no "trade imbalance" once all international transactions are accounted for:

1. In 2009, the U.S. imported more from China ($354 billion) than it exported ($93 billion), resulting in a "trade deficit" of -$263 billion on our "current account" (data here).

But that is only part of the international trade story, since there are also financial transactions that have to be accounted for, and that deficit on the current account has to be offset somehow, since all international trade has to balance (it's based on double-entry bookkeeping).

2. The offsetting balance came from the $263 billion capital account surplus in 2009, as a result of $263 billion of net capital inflow to the U.S. from China to buy our Treasury bonds and other financial assets.

3. The $263 billion capital account surplus exactly offsets the current account deficit.

Bottom Line: As Don correctly points out, there really is NO trade imbalance, when we account for: a) exports and imports of goods and services, AND b) capital inflows/outflows. Stated differently, the balance of payments is always ZERO. We buy more of China's goods than they buy of ours, but then China buys more of our financial assets (bonds and stocks) than we buy of theirs. So in the end, international trade with China, is balanced, not imbalanced.