How the US Created a $500 Billion Trade Deficit

The US trade deficit has been growing since 1971. Today, it’s the largest deficit in the world.

The U.S. trade deficit is a common news story. At $505 billion last year, it’s the largest trade deficit in the world. In fact, it’s more than four times larger than Great Britain’s trade deficit, the country with the second-highest debt.

How did the U.S. trade deficit grow to be so massive? Is it even possible to lessen the deficit moving forward? Read on to find answers to these questions and to get more information about how a trade deficit affects the greater economy.

How a Trade Deficit Occurs — and What It Means for the Economy

The United States calculates its trade deficit by comparing the dollar amount of exported goods and services to that of imports. In 2016, the U.S. exported $2.2 trillion worth of goods and services and imported $2.7 trillion worth of goods and services.

The biggest U.S. exports last year included:

  • Capital goods (civilian aircraft, semiconductors, electric, telecommunications equipment): $520 billion
  • Industrial supplies (petroleum products, chemicals, plastics): $396 billion
  • Consumer goods (pharmaceuticals, cell phones, gem diamonds): $194 billion
  • Automobiles: $150.3 billion
  • Foods, feeds and beverages (soybeans, meats, corn): $130 billion

The biggest U.S. imports in 2016 were:

  • Capital goods (telecommunications, computers, electric apparatus): $590 billion
  • Consumer goods (cell phones, apparel, pharmaceuticals): $583.6 billion
  • Industrial supplies: $443.3 billion
  • Automobiles: $350.1 billion
  • Foods, feeds and beverages (vegetables, fish, coffee): $130 billion

A $505 billion trade deficit seems huge, but it pales in comparison to the size of the U.S. economy, which reported a gross domestic product (GDP) of $16.8 trillion last year. According to the World Bank, the import of goods and services as a percentage of GDP was 15.4 percent in 2015, much lower than some of the world’s biggest economies, including China (18.5 percent), Japan (18 percent) and Germany (39.2 percent). The higher the percentage, the more sensitive that country’s economy is to trade.

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Why the US Trade Deficit Is So Large

In the 1960s, the U.S. reported a trade surplus every year, reaching as high as $6 billion in 1964. The trade deficit began in 1971, with $1.3 billion owed that year. The U.S. has posted a trade deficit every year since 1974.

A trade deficit can be caused by a wide variety of factors, such as the price of oil. When the price of a barrel of oil jumped to almost $140 in 2008, petroleum imports rose to $453 billion compared to, say, $103.5 billion in 2002. The trade deficit increased to $830.1 billion in 2008, compared to $482.3 billion in 2002.

The U.S. dollar also affects the trade deficit. If the dollar strengthens, other countries cannot afford to buy as many goods, according to YiLi Chien, a senior economist at the Federal Reserve Bank of St. Louis. In contrast, if the dollar weakens, other countries can buy more American products, thus boosting exports and the U.S. economy. This activity might decrease the trade deficit, according to Chien.

Another reason might be that foreign countries impose high tariffs or other barriers to U.S. products to protect their own domestic industries, such as the Japanese car industry. Don’t forget that presidential policies can also affect trade and, therefore, the trade deficit.

US Trade Deficit by Country

In 2016, the U.S. trade deficits were largest with China ($347 billion), Japan ($68.9 billion) and Germany ($65 billion). But just because the U.S. owes money to these countries does not mean they didn’t buy anything from the U.S. In fact, China bought $116 billion worth of goods from the U.S., up from $55.2 billion a decade earlier. Japan purchased $63.3 billion, and Germany purchased $49.4 billion.

Other big buyers of U.S. products in 2016 included Canada ($267 billion) and Mexico ($231 billion). The trade deficit with Canada last year was $11.3 billion, and the U.S. trade deficit with Mexico was $63.2 billion.

In 2016, the U.S. reported its largest trade surplus with Hong Kong ($27.5 billion), followed by the Netherlands ($24.2 billion) and United Arab Emirates ($19 billion).

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Possible Steps to Lessen the US Trade Deficit

A trade deficit can be reduced by a variety of ways. For example, a country could depreciate or weaken its currency — like China has done. Such a move helps a country maintain its competitiveness in the international market.

According to the White House website, President Donald Trump and his administration have taken or intend to take the following steps to lessen the U.S. trade deficit:

  • Withdraw from the Trans-Pacific Partnership
  • Make sure deals “are in the interests of the American workers”
  • Renegotiate or withdraw from the North American Free Trade Agreement (NAFTA) with Mexico and Canada
  • “Crack down” on those nations that violate trade agreements

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Does a Growing Trade Deficit Signal a Faltering Economy?

Answering this question is more difficult than it might seem.

For example, say a U.S. company has determined to buy a product overseas because it is cheaper but then sells that product in the U.S. This can cost U.S. jobs. However, because the company bought the product for less, it might sell it for less to U.S. consumers, which helps consumers save money.

Then there is the inference that the national wealth is leaving the United States. In reality, trade partners like China often take trade profits and invest them in the U.S., particularly in Treasury securities. As of April, China held $1.09 trillion in U.S. Treasury securities. If a country like China decides it doesn’t like the U.S. trade policy, it can sell its bonds — but then it runs the risk of selling them at a loss, which is to the benefit of the buyer. These eager buyers include many Wall Street firms and at least 32 other countries that hold U.S. Treasury securities.

Trade Services, a Trade Success Story

One of the least known success stories on trade is services, which was $752.4 billion in 2016, up from $6.3 billion in 1960. Revenue from services has risen in 54 of the last 57 years.

Last year, the biggest generator of service revenue was travel ($206 billion). This sector includes visitors to the U.S. who buy plane tickets on U.S. carriers, hotels, food, recreation and similar items.  Another large service sector was intellectual property ($124.5 billion), which includes the use of patents, techniques, processes, formulas, designs, know-how, trademarks, copyrights, franchises and manufacturing rights.

The third biggest was for financial services ($98.2 billion). This area includes commissions and other transactions fees associated with the purchase and sale of securities and noninterest income of banks. Other services provided by Americans overseas include transport, maintenance and repairs, telecommunication and computer services, insurance and government goods.

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