Does the US have a Hidden Trade Surplus

I seem to be in a mood to reevaluate my beliefs these days. The latest reevaluation came around the US trade deficit. It’s big at over $1 trillion per year. But that’s just for goods. Physical stuff: TVs, computers, drones, furniture, etc.

We actually have a trade surplus in services. The heart of that is our large tech companies: Microsoft, Alphabet/Google, Meta, etc. They sell Europeans and many in the rest of the world software. However, that surplus is a lot smaller, $250-300 billion per year.

It nets out at about little less than a trillion dollars give or take. That’s just eyeballing it. Even in a $27 trillion economy like the United States, that’s real money. It also drives our deficits.

Profit Adjusted Trade

However, an investor I follow that I’ve mentioned here before, Russell Clark, has done some innovative thinking (paywalled) about this. If you have a large trade deficit, your currency should weaken. If we keep sending dollars overseas, that should pump up the value of those currencies relative to the dollar.

Instead we’ve seen a strengthening dollar even as the trade deficit widens. What’s happening here?

I’ve been persuaded by Michael Pettis, a professor at the Tsinghua University in Beijing, to chalk the strong dollar up to China and other surplus nation’s efforts to recycle dollars they receive from trade back into US financial assets: stocks, Treasuries, mortgage bonds, etc.

That, all else equal, would keep the dollar strong against their currencies and their exports competitive. Most of the trade policy of the current US Administration is based on this supposition.

Clark raises an alternative explanation. He writes:

And he helpfully provides a profit adjusted chart:

According to Clark, the US might actually have a trade surplus when you add the goods deficit to the services surplus and adjust it for actual profits. And profits and the cash that flows from them are what matters in the end. That’s what you have left over to invest, save, or spend. As one of my business mentors says, "Revenue is vanity. Profit is sanity and cash is king.”

Could it be that it isn’t just the dollars Beijing is recycling but the very real profits Japan, Europe, and Canada are sending back to us that keeps US asset prices high? It seems plausible to me. So what are the implications?

Who Wins a Trade War?

It follows from Clark’s thesis that if the US throws up trade barriers and tariffs against imported goods, other countries will attack the US services surplus. The surplus nation is the one who loses more in a trade war. We thought that was everyone else but maybe it’s us who has more to lose?

That’s a bit mind blowing. Why would we trade an increased share in low margin manufacturing goods that will presumably fetch even lower margins in the more costly US for a lower share of high margin services? Sounds like a bad deal to me. It’s like saying, ”Let’s shut down our SaaS business with 80% margins and start a factory selling auto parts for 5-10% margins.”

Some Caveats

Let’s not go too far in this analysis without some caveats. I’d like to see a deeper analysis of Clark’s idea first. Not all services are created equal. Some like tourism are probably as low margin as many goods and some goods (think high manufacturing equipment like lithography machines for semiconductors) are very high margin.

We don’t have a detailed study that I can find on the actual net of our trade on a profit basis. I also believe that a healthy economy and a nation that can defend itself needs to have some level of manufacturing. We have sacrificed a lot of it. There does need to be some balance there even if it hurts services a bit.

Finally, there are the distributional issues. Tech and software jobs tend to go to the college educated and those companies seem to create fewer jobs overall. In general services don’t favor non-college educated men.

A Better Approach

Given all these considerations, I think my favored approach translates well to the ideas I laid out in A Time for Choosing a couple of weeks ago. In it I lay out a few options for the US in reshaping our global trading and economic system. The option I believed we should choose, given that China is not going to cooperate, is to build an international coalition of allies to curb China’s surpluses and global power.

Our most valuable services surplus is with Europe, Japan, South Korea, the UK, and Canada. These are our allies. If we take on the whole world by slapping tariffs on the EU, Japan and others, we get penalized in services from our allies. If we can jointly raise barriers with our allies against China, we keep our services surplus intact.

This is a far more strategic approach. I’m not sure we are going to pursue it but our policy seems to change day-to-day so it’s hard to say. I’ll be watching.

Keep learning,

Alan

P.S.

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