What’s a Trade Deficit?

Talk and tension around a trade war between China and the U.S. are heating up. This has brought up another hot topic: the trade deficit.

The trade deficit is one one of the rationales offered by the Trump administration for possibly imposing stiff tariffs on a wide array of Chinese exports.

What is the trade deficit?

In simplest terms, a trade deficit, sometimes referred to as a trade gap or an account deficit, is when a country imports more than it exports, which can lead to all kinds of economic issues.

But what does the trade have to do with billions of dollars worth of potential tariffs on Chinese goods, such as steel and aluminum?

We’ll break it down for you.

Let’s talk trade

We live in a global economy. Nations import and export their goods, to and from each other all the time. In fact the global economy for exports is worth a staggering $16 trillion, according to the World Trade Organization.

All countries have what’s called a trade balance–that’s the sum of what it imports and what it exports. If a country imports more than it exports, it has a negative trade balance, or deficit. If it exports more than it imports, it has a positive trade balance, or surplus.

Why do countries trade?

Think of it this way: Companies in a particular country produce goods they want to sell. There’s a domestic market for sales, but there are also foreign markets–other countries might want to buy what another country produces. And that’s particularly the case if that country doesn’t manufacture or grow those things itself.

The U.S., with its rich farmland in the Midwest and elsewhere, is one of the largest exporters of wheat, for example. And although the situation has changed dramatically in recent years,  the U.S. used to import much of its petroleum from the oil-rich Middle East, when it seemed like our own supplies were limited.

Getting it cheaper from someplace else

But it’s not always the case that a country imports a particular good because it doesn’t have it, or produce it domestically. Sometimes wealthy countries such as the U.S. purchase exports simply because the goods may be cheaper than what they can produce themselves.

For decades that’s been the case with the U.S. and China, and other Asian countries, where the price to produce common items from clothing to electronics is often much less expensive than the cost to produce the same items domestically.

In fact, China’s access to cheap labor and sophisticated manufacturing has made it the biggest exporter in the world.

Cheap products are great for U.S. consumers who benefit from the reduced prices. On the other hand they may not be so good for U.S. workers, if the jobs producing those items are all based overseas.

This is the theory of the Trump administration, which has said our trade deficit is killing jobs at home.

Surplus vs deficit

If a country imports more than it exports, that country runs what’s called a trade or account deficit. That’s in contrast to an account surplus, if a country exports more than it imports.

Simply put, a surplus is more appealing than a deficit, because it puts a country’s economy in a stronger position.

Here’s why: It actually costs us money to import more than we export. In order to buy all those goods from overseas, U.S. companies exchange dollars for the local currency of the country manufacturing what we buy.

Here’s where it gets a bit complicated.

That means U.S. dollars accumulate in central banks overseas, which typically use those dollars to purchase our Treasury debt, since it pays interest.

But Treasuries are a form of debt. So those export dollars wind up as loans to the U.S. government, essentially increasing national debt.

What does this have to do with the U.S. and China?

Currently, the U.S. exports about $2.2 trillion of goods and services annually, and imports about $2.7 trillion, according to International Trade Administration. That means we have a trade deficit of roughly $500 billion annually.

Most of that gap, or $375 billion, is with one country–China. And that’s a prime reason why President Trump has called for the tariffs.

His hope, based on the theories of his economic advisors, is that tariffs will reduce the trade deficit by making Chinese products more expensive for the U.S. to import.

That in turn, Trump and his advisors have suggested, could increase U.S. manufacturing and jobs.

Will it work?

Time will tell. Tariffs are not a one-way street. China has threatened to retaliate with billions of dollars worth of its own tariffs, which could give U.S. manufacturers and exporters a hard time.

Aerospace manufacturer Boeing, for example, has voiced concerns recently that a trade war could harm its U.S. business.