Nothing causes more anger, confusion, and bewilderment than the trade deficit – that is, except for the federal budget deficit. In past decades, these were often called “the twin deficits.” They are not identical, but they are related.
The current account balance is the trade balance (we currently run a surplus in trade services, which is more than offset by a deficit in trade goods), plus balances on primary income and secondary income – but it’s mostly the balance in goods and services. Primary income includes investment income and compensation of employees. Secondary income includes transfers (government and private), “such as U.S. government grants and pensions, fines and penalties, withholding taxes, personal transfers (remittances), insurance-related transfers, and other current transfers.” The numbers are large (the current account deficit totaled $123 billion in 2Q17), so you need to scale that relative to GDP to compare it over long periods of time. The current account deficit reached 6.3% of GDP in 4Q05, a worrisome level, but has moderated in recent years, down to 2.6% of GDP in 2Q17.
President Trump has said that the trade deficit reflects poor negotiations in international trade agreements. Other countries “have been taking advantage of us.” Economists do believe that. The trade deficit reflects the strength of the U.S. economy (if we consume more domestic goods and services, we can expect to consume more imported goods and services) and, importantly, the ability to borrow cheaply from the rest of the world. If the U.S. runs a trade deficit, it must import capital to finance that. Alternatively, if the U.S. does not save enough relative to its consumption, it has to borrow from the rest of the world – and that means that it has to run a trade deficit.
There is a simple way to reduce the trade deficit: have a recession. The trade deficit fell sharply in the 90-91 recession and in the 08-09 recession, but not by much in the 2011 recession (which was relatively mild by historical standards).