Trade Deficit Trifles

Thursday, the Commerce Department reported the July US trade deficit posted its biggest drop in nearly two and a half years. Exports surged higher and imports were slightly lower (-0.2%) as the trade deficit shrank approximately $6.8 billion to -$44.8 billion—off the peak deficit in June of -$51.57 billion.

And yet, the trade deficit seemingly can’t get a break—while it’s expanding, many lament it’s a sign of the US’s fall from economic dominance. When shrinking, it’s frequently decried as a possible sign of economic weakness (never mind that for this report, imports were lower mainly on depressed oil prices) .

Either way, it seems to us the focus many have on trade deficits stems from a misunderstanding of how GDP is calculated. One component is net exports—so a trade deficit detracts from headline growth. But the very fact GDP counts imports as a detraction shows it doesn’t perfectly reflect economic health (as we discussed here). Imports can create a vast array of real economic value for consumers, businesses and the countries importing those goods or services.

In our view, total trade is actually what matters most. Thinking globally, the notion of a trade deficit (or surplus) is relatively meaningless. One country’s deficit is another’s surplus (and vice versa) . But total trade measures overall global commerce. The higher the number, the more overall economic activity going on throughout the world—something we can all be thankful for. And as shown in Exhibit 1, total trade dipped in early 2009 (during the recession), then reaccelerated as economic growth resumed, whereas the trade deficit’s movements aren’t indicative of very much.

Exhibit 1: US Total Trade and Trade Balance

Source: US Bureau of Economic Analysis. NBER recession shaded.

In July’s report, exports reached a new all-time high and total trade stands only a hair below its May peak. In fact, after June showed a monthly decline, July’s data showed reacceleration in activity. In fact, since the recession’s June 2009 end, overall trade has accelerated in 21 of 26 months and five of 2011’s seven monthly reports to date. What does that say about global and US economic health?

Rising total trade, such as we’ve seen since the recession’s end, is a solid indication of global economic growth. And the fact July’s trade reaccelerated is another point showing early summer’s weak data likely represented a soft patch and not a new recession beginning. The global economy is a giant cooperative—and health abroad can be a key cog in our own. Which, we might add, was a point we were rather pleased (and a touch surprised) to see a politician make in a New York Timesop-ed today. After all, other members of our body politic desire to do bizarre things like pass legislationlaunching an emergency federal commission on the trade deficit. (Which, thankfully, is nowhere near going anywhere.) As such, the trade deficit is a rather meaningless marker in determining economic health.