There’s No Such Thing as a Trade Imbalance

By Michael Taillard from Corporate Finance For Dummies

At no point in a typical retail exchange do either you or the store owner have a trade imbalance, because the value of goods and money being exchanged are equal.

The store owner, having given a thing of value to you, is now in possession of a piece of paper that symbolizes the value of debt that society owes him in the form of goods and services. (Money is meaningless except as a measure of how many goods and services are owed.) The store owner holds onto the money you gave him for a little while and then uses it to purchase goods and services for himself.

National trade works in a similar way. Nations keep track of all the trades they make in their balance of payments. The two primary accounts in the balance of payments are

Current account: The current account measures the amount of consumable goods entering or leaving a country. (It’s what people are talking about when they discuss trade deficits and surpluses.) These goods may include food, cars, machinery, customer service, employment, or anything else being purchased. A current account deficit means a nation imports more goods than it exports; likewise, a current account surplus means a nation exports more than it imports.
Capital account: The capital account consists of investments one nation makes in another nation’s economy, such as the value of new business start-ups, the value of stock and bond purchases, and even the transfer of money related to imports and exports.

So when Nation A exports goods to Nation B, it does so with the expectation that the currency Nation B gives it will later be traded for a greater amount of resources than Nation B gave it this time. In other words, the whole process of exporting is an investment.

Here’s a more personal example: If a person tried to buy something from you by using some type of money that you couldn’t spend or convert into a useable type of money, would you still sell to that person? Of course not.

An increase in one of these accounts always results in a decrease in the other. So when a nation has a current account deficit, it also has a capital account surplus.

A nation can sustain a current account deficit as long as the people of other nations are confident that they’ll be able to use the currency they receive for their exports to purchase other goods and services from the importing nation or other nations interested in the importing nation’s currency.

The real issue is whether or not the value of the nation’s exports will increase over time relative to the value of its imports.

In other words, a nation will want to know whether all the money its spending will boost the total value of its productivity in a manner that will allow it to meet its export obligations later (because other nations now hold their currency) while still maintaining enough production to meet domestic demand and whether corporations are treating imports as capital investments (hence, a capital account surplus) or mere consumption.