One of the more frustrating “Trumpisms” is his idea that in order for American to “win,” US exports must exceed US imports. He sees the entire country as just one big corporation whose sole purpose is to make a “profit” by exporting more than it imports (that is, sells goods at a greater value than what it paid for them). This simplistic viewpoint is deeply flawed. It presumes trade is a zero-sum game where one side always “wins” and the other side “loses” in the exchange. Indeed this mindset would mean every time we buy groceries the store has “won” and we have “lost.” Trade is always a win-win game; both parties have gained more than they gave up, otherwise they would not have made the exchange.

Viewing trade at a macro-level is myopic at best (as it ignores the underlying individual decisions being made by billions of people) but in order to make a point we will proceed with that fiction. That point is this: a trade surplus or deficit can never exist. Although that may sound shocking at first it really shouldn’t when you consider the nature of any trade. If I buy a candy bar, I hand the clerk a few dollars. Does the store now have a trade surplus with respect to me? Do I have a trade deficit with respect to the store? Of course not. The store traded away a candy bar and traded in money. I did the exact reverse. So when we consider China and US trade we see that China sends us a whole host of goods and we send them green paper rectangles. Now, ignoring the fact that Federal Reserve is constantly swelling the money supply for its friends on Wall Street, we’ll assume that the supply of US currency is constant. Given that assumption we must ask: how did we acquire those pieces of paper to give to China? We got them by producing goods and services for someone else. So if we send $x to China for $x worth of goods A that means we had to first produce $x worth of goods B. China didn’t want goods B, they wanted the money. That is the nature of indirect exchange and is why money is an emergent property of trade (it solves the double coincident of wants problem).

Ok, but some will say that’s all fine and good, but the problem we have is that the total export of goods to all countries is less than total imports of goods from all countries. So even though the US may have a trade surplus with respect to US dollars, we have a deficit with respect to goods. That is true. But it doesn’t it matter, or rather it shouldn’t matter. The only reason this is viewed as a problem is because of the artificial attempts to solve it actually make the problem worse. In order to explain the problem we must once again assume that the quantity of money is constant. In that case, as more goods come into the US and more money flows out of the US there will be fewer and fewer dollars remaining in the US. This is called deflation (a contract of the quantity of money). This is natural and does not cause depressions or any other nonsense like that (no matter what your 4^th grade teacher told you). Under deflation money is in high demand (because there isn’t a lot of it), which means the money price of goods decline (in order to get that scarce money, people will trade more and more goods for it – hence prices fall). So if prices of goods made in the US fall, what do you think that would do in terms of making American goods more competitive to overseas buyers with fistfuls of dollars? That’s right, they’ll start buying all those cheap US goods which will naturally swing the trade pendulum the other way, with more goods leaving the US than coming in and likewise more money coming in than leaving.

That this does not occur presently is a testament to how much the Federal Reserve and US monetary policy has distorted these natural incentives. The Federal Reserve short circuits this natural feedback system and inflates the money supply. This very temporarily makes US goods cheaper overseas (buy devaluing the exchange rate of the US dollar relative to other currencies that are inflating less rapidly), but (a) it doesn’t last long because other countries quickly adjust their inflation to counterbalance the effect and (b) it has the deleterious side effect of making US goods MORE expensive for US buyers (that’s what inflation does, it increases the money price of goods). So, under the natural system of deflation ALL prices fall which benefits both domestic and international trade. However under the artificial Fed induced inflation system we have domestic prices rise while relative prices for international buyers fall for a short period but then quickly also rise resulting in market disruptions and distortions. Using money creation to solve trade problems is like rowing a boat with one paddle forward and the other paddle backwards.

If we want to “fix” trade we need to examine the current incentives created by the distortions into the market introduced by Fed monetary policy. Only then will we see we need to do less, not more, to “fix” the situation.