Editor’s Introductory Note: This article is a guest post that I selected from a contrarian economist and investment advisor. It first appeared at the Lyn Alden Investment Strategy web site.
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Due to the ongoing trade dispute between the United States and China, as well as between certain other nations, the concept of a trade deficit is now front and center in financial media.
This article takes a look at why trade deficits (eventually) matter, and how they can factor into an investment strategy.
The short version is that trade deficits, along with a few other factors, tell us whether a country’s
currency is more likely to strengthen or weaken going forward.
However, it often takes several years for trade deficits to matter for a currency, which means that for the vast majority of investors and traders, trade deficits aren’t really factored into their analysis. Trade balances are not usually a short-term piece of trade-able data, in other words.
Instead, understanding trade deficits is more actionable in regards to long-term portfolio positioning.
Terms Defined
Trade Balance- A country’s trade balance measures the value of goods and services it exports compared to the value of goods and services that it imports. A country that exports more than it imports (i.e. produces more than it consumes) has a trade surplus. A country that imports more than it exports (i.e. consumes more than it produces) has a trade deficit.
For example, if the United States buys $500 billion worth of goods and services from China each year, and China buys $200 billion worth of goods and services from the United States each year, then the United States has a $300 billion trade deficit and China has a $300 billion trade surplus. A country’s overall trade balance is measured by adding up all the various trade surplus and trade deficits it has with all of its trading partners.
Current Account Balance- A more “complete” picture of a country’s inflows and outflows. The current account balance includes the trade balance, plus investment income between nations, plus cash transfers. A country with a current account surplus has more value flowing into it. A country with a current account deficit has more value flowing out of it.
For example, if the United States has a $300 billion trade deficit with China, but owns enough companies in China that they receive $100 billion worth of dividends each year, then the United States only has a $200 billion current account deficit with China, and China has a $200 billion current account surplus with the United States.
Net International Investment Position (NIIP)- Private citizens and government organizations of a country may own assets of other countries, like real estate, shares of corporations, bonds, and so forth. A country’s net international investment position is determined from the total amount of foreign assets its citizens and government own minus the total amount of domestic assets that foreign citizens and governments own.
For example, suppose United States citizens own $1 trillion worth of Japanese real estate, Japanese citizens own $2 trillion of U.S. real estate, and Swiss citizens own $1 trillion worth of U.S. real estate and $1 trillion of Japanese real estate. In this example, the United States has a -$1 trillion negative international investment position, Japan has a $0 net international investment position, and Switzerland has a +$2 trillion positive net international investment position.Continue reading“Why Trade Deficits Matter, by Lyn Alden”