Trade Balance
It’s huge. And it disturbs many people, in particular President Donald Trump. The trade deficit with China. In 2018, it reached $419 billion. Actually, the U.S. runs trade deficit not only with China. As the chart below shows, America’s trade balance is negative, which denotes a trade deficit, with the rest of the world. And this imbalance has been deepening since 1992.
Chart 1: US trade balance (goods and services, in millions of $), from January 1992 to April 2019.
What does it mean? Well, trade balance is exports minus imports of goods and services. Hence, trade surplus occurs when the value of a country’s exports exceeds the value of its imports. On the contrary, when the value of a country’s imports exceeds the value of its exports, as it is in case of the U.S. - China trade, or more generally the trade with the rest of the world, we talk about trade deficit.
Is trade deficit something bad? After all, having a deficit does not sound nice. However, we all are running trade deficits with somebody. For example, if you buy stuff at Walmart, you run a deficit with that store. But this is not the problem, because it balances with a trade surplus with your clients or employers.
You can say that the U.S. runs a trade deficit with the world as a whole. True! But it is still balanced – but by the capital surplus. You see, the trade balance is only a part of the wider balance of payments, which is a yearly summary of all the economic transactions between residents of one country and residents of the rest of the world. Let’s assume that U.S. consumers spend money on computers produced in China. The Chinese producers get money and they must do something with the greenbacks. If they buy American cars, then the trade account would be balanced. However, they can buy instead Treasuries. In such scenario, the U.S. runs trade deficits (i.e. current account deficits), but its capital account increases – the overall balance of payments is still balanced.
It works both ways. It’s debatable whether a country privileged to have the world reserve currency can possibly run a trade surplus. After all, other countries need the world reserve currency for their own trade and foreign exchange reserve purposes. And these dollars have to come from somewhere. Enter the much-maligned trade deficit – an in-built consequence for the country that enjoys issuing the world reserve currency. You can’t both have your cake and eat it, right?
Trade Balance and Gold
Now we know what is trade balance. But what is the link between the trade balance in general and the gold market? As we showed above, it would be wrong to focus on the mercantilist view that a trade deficit is a problem in itself. It isn’t, as it is balanced by the capital surplus. When capital flows into the U.S., it works to strengthen the U.S. dollar and by extension weaken gold.
However, the trade deficit might indicate a problem of low savings. Americans are consuming too much and not saving enough. The difference is being made up by foreign borrowing. Tangible goods are imported and paper promises are used as payment. The government also spends too much, so it must borrow from abroad to cover its fiscal deficits and ongoing interest payments. This way, the U.S. trade deficits reflect the excessive indebtedness. When the public debt (or private debt) gets outs of control, gold may shine.
Another potential link between the trade balance and gold is trade wars. As some politicians do not like trade imbalances, they impose certain protectionist measures, and engage in trade disputes. It may increase the safe-haven demand for gold (although the exchange rate channel also enters the scene).
All theory is gray and green is the tree of life. The chart below overlays the U.S. trade balance with the rest of the world and the gold prices, and does not show a very tight relationship between these two data series. The trade deficits were getting bigger in the 1990s, when gold was in the bear market, and in the 2000s, when the yellow metal entered its bull market.
We better look for more clues. It certainly matters if the world reserve currency and the economy enjoys a strong growth trajectory driven by innovation, increasing productivity and productive capital investments. These certainly foster the confidence in the reserve currency’s strength and the country’s ability to service its debts. When the rate of indebtedness rises faster than the real economy grows, the horizon darkens and the feared bond vigilantes show up. A credit crisis follows and that’s the time for gold to shine.
Chart 2: US trade balance (red line, left axis, goods and services, in millions of $) and gold prices (yellow line, right axis, London P.M. Fix, in $), from January 1992 to April 2019.
