But are trade deficits necessarily bad for the U.S. economy?

The answer is no. Trade deficits are not a sign of unfair trade practices or a lack of American “competitiveness.” Trade deficits are caused by factors in the macroeconomy that are not directly related to trade. To understand why, journalists should borrow a technique from investigative reporting and “follow the money.”

When Americans buy imports, foreigners must do something with the dollars they earn. They can either use the dollars to buy American exports or to invest in American assets, such as Treasury bills, stocks, real estate, and factories.

If the amount of investment capital entering the U.S. exceeds the amount flowing Out, the extra dollars entering the country can then be used by Americans to buy imports over and above the amount we could buy merely from what we earn by selling exports. So a current account deficit is simply the mirror image of a capital account surplus.

In the global economy, some countries, such as the United States, are net importers of capital and thus run a trade deficit. Others, such as Japan, are net capital exporters because domestic savings exceed domestic investment. The excess savings these capital exporters send abroad returns to their home market to purchase exports, creating a trade surplus.

One reason for a trade deficit can be that the deficit country is growing faster than its trading partners. Faster growth attracts investment dollars, which, along with rising incomes, allow the deficit country to buy more imports on the global market.