We Didn’t Lose Money—We Attracted it

Over 25 years, the U.S. doubled real GDP, expanded manufacturing output, and drew trillions in capital inflows—despite running persistent trade deficits

Tariffs and trade deficits are top of mind for the business community and the broader world of market participants—which is to say everybody. Without wading too deep into questions of politics, I want to delve into what is going on. Specifically, what is it that we are trying to fix here?

There is a certain intuitive logic to the idea that a country that imports more than it exports on either a bilateral or aggregate basis is losing money. This is intuitive but misleading. The ominous term “trade deficit” to describe a negative current account balance reinforces a narrative of industrial decline, job loss, and weakening national strength. However, this interpretation misreads both macroeconomic theory and the data.[1]

First, I want to address the mistaken belief that a trade deficit represents somehow a loss of money. For this I turn to a stylized scenario: let us imagine that the United States buys $1,000 worth of goods from Country X. This leaves the US with $1,000 worth of goods to sell internally or export on further—at a profit no less. At a minimum this means there is now $1,000 less cash but a minimum of $1,000 of utility and value in the American economy—at worse this is net zero and more realistically additive to the overall value of the American economy. The US has lost nothing so far. But Country X now has $1,000 that it must do something with—it cannot put 10 Ben Franklins in a shoebox. Let’s say that they don’t want any American goods or services. This leaves one option—it must reinvest those dollars in dollar denominated securities. This means they must invest in the United States economy. This is the core of the accounting identity that a trade deficit is mirrored 1:1 as capital inflows.

Why would a foreign market actor prefer to invest in the US over buying American goods?[2] The short answer is not because they don’t like our goods but that they love our economy’s ability to produce growth. This is compounded by the fact that the goods and services we do export are generally exceptionally high value and many countries aren’t in the market for high end industrial equipment, or fighter jets. Not only do these foreign market participants prefer the US as a return generating machine—their investments contribute significantly to the appreciation in US capital stock. As we can see below the appreciation of capital stock drives total factor productivity. In short we have a virtuous circle wherein the productive capacity and efficiency drives investment in the US money making machine and these inflows make the machine better at making money which drives more investment and so on. It is no surprise that on net foreign market participants would prefer to put their dollars back into this machine than to buy a half tonne pickup truck that doesn’t fit on their quaint narrow roads. Trade is at a core an exercise in maximizing utility through comparative advantage, and while the US has many, its number one comparative advantage is the ability to make money for investors.  

But surely this is a sacrifice placing manufacturing and the productive economy on the altar of capital return? Not the case. Not only has the US industrial base not been hollowed out—it has grown by about 13.4% over the last quarter century—a period characterized by dramatically increased globalization. It is worth noting at this point that this is in an economy dominated by services and not good production-- the value added to the US economy by the service sector was over 70% of GDP in 2024. Did the trade deficit increase over this period? Yes. But the data below show that the relationship between variation in manufacturing output is tenuous. An R² value of 0.167 shows that only about 17% of the variation can be explained by the trade deficit. Yet we talk about a chimerical destruction of our manufacturing sector driven by manufacturing being driven overseas. This is clearly not the case.  

The critic may respond by noting that the manufacturing we do have is highly automated and that we have lost jobs regardless by sending them overseas. There is a grain of truth here—the United States’ manufacturing economy has always been on the capital-intensive side of the spectrum. In the late 18th and early 20th centuries this was driven by water and steam powered textile mills and now it’s by robots. Admittedly over the last quarter century manufacturing employment has decreased by about 25%. But if we look at the data, we see that there is no meaningful relationship between this decrease and the trade deficit. It is much more likely to be explained by American workers shifting to higher paid service sector jobs—real median household incomes have increased by about 15% over the same period

But, the critic will insist, this persistent trade deficit has made us poorer. To that, I simply present the following: real GDP has more than doubled since 1999—through three recessions—despite running a persistent trade deficit the entire time. If trade deficits truly drained national wealth, this growth wouldn’t have happened.

As we continue down the road of discussing the fixes that the US needs to make with its global trading partners—we ought to keep in mind a few things. The trade deficit has not hollowed out our manufacturing sector—in fact output is up. It has not even meaningfully contributed to the decrease in manufacturing employment. It has not made us poorer—we have doubled our real GDP over the first quarter of this century. Far from being a weakness—it shows that our economy has been an engine for economic return that is the envy of the world. Let’s make sure that we don’t let an easy and intuitive but fundamentally wrong interpretation drive us to make decisions that will put this in jeopardy—impoverishing ourselves and our friends across the globe.  

[1] If I were being snarkier I would point out that this is all a fundamentally mercantilist viewpoint—as though we live in a zero sum world with a money supply constrained by a fixed amount of gold and silver bullion. Not that we ever did. The Spanish proved this in real time by creating massive inflation when they pulled all the silver out of the Cerro Rico—flooding the global money supply. At, this point Cicero would point out that I have not avoided being snarky. Even when mercantilism was the dominant economic theory—it was demonstrably incorrect.

[2] To be clear they do both—but in aggregate our current account shows we are in a net position where they prefer investment over goods.