Why does President Trump consistently signal that he is displeased by inflows of foreign capital into the United States?
Foreigners purchase U.S. stocks, bonds and currency. Foreigners invest directly in the U.S. by, for example, purchasing commercial real estate. Because the U.S. has a greater appetite for investment — the construction of office buildings and manufacturing plants, the purchase of new technologies and equipment, upgrading and replacing old capital — than can be satisfied with national savings, foreign capital finances domestic investment.
Generally speaking, this is good. It is a vote of confidence in the U.S. economy and in our nation as a whole. It is also good because we want the capital goods, and we don’t save enough for them.
You likely haven’t heard Trump criticize international capital flowing into the United States. At least, not directly. But when the president and his administration attack the trade deficit, they are attacking foreign investment in the United States.
How so? Because when we import capital from abroad, we run a trade deficit. Trade deficits and capital flows from abroad go hand in hand.
There are a few different ways to understand this. First, consider trade flows. When we import more than we export, we are consuming and investing more than we produce here at home. To pay for that consumption and investment, we need to borrow money from the rest of the world. We sell the rest of the world assets, and they give us money to pay for the consumption and investment we want — levels in excess of domestic production. Therefore, trade deficits require inflows of foreign capital.
Second, consider saving and investing over time. Today, the U.S. wants to invest more than it saves, so it borrows from abroad — foreign capital enters U.S. markets. For that foreign capital to exist, the rest of the world needs to be saving — i.e., not consuming and investing. So some of their output comes to the United States. It enters the U.S. and finds its way into retail stores, in which Americans buy goods made in foreign countries. And it enters the U.S. through government borrowing, which flows into transfer payments, which are used by households to buy goods and services, some of which are made abroad. Again, trade deficits and inflows of capital go hand in hand.
Third, consider interest rates. Demand for investment that outpaces the supply of savings pushes interest rates up, attracting foreign capital to the United States. But to buy U.S. assets and enjoy their higher interest rates, foreign investors need dollars. Increased demand for dollars increases the value of dollars on foreign exchange markets, which dampens exports and increases imports — ergo, foreign capital comes in, and the trade deficit increases.
No matter what angle is most intuitive, the bottom line is the same: If the president wants to significantly reduce the trade deficit, he also wants to significantly reduce inflows of foreign capital. Waging a war on the trade deficit is waging a war on foreign investment.
We have already incurred costs associated with our retreat from international markets. Research published by the Peterson Institute for International Economics finds that the Trans-Pacific Partnership trade deal would increase U.S. income by around $130 billion per year once the deal was fully implemented. If you were walking down the street and saw $130 billion on the sidewalk, would you stop to pick it up? Not this administration, apparently. And much more than money was lost when we embarrassingly turned our back on the TPP.
We will lose something deeper, as well.
Retreating from free trade represents a partial retreat from the liberal order that has maintained peace and dramatically advanced prosperity since the end of World War II. Retreating from free trade means retreating from the single most effective tool to reduce abject, miserable poverty the world has ever seen.
Retreating from free trade is a partial retreat from the history shaping idea that free exchange is good, and that two individual parties should be left to their own judgment as to whether a trade of goods, services or income makes both parties better off. Retreating from free trade means embracing industrial policy, reducing long-term growth, pulling back from a position of leadership in the world, increasing the role of government, and decreasing political and economic liberty.
For what? The impossible fantasy of taking the U.S. economy back to the 1960s?
The American people deserve better than fantasy.
Michael Strain is a resident scholar at the American Enterprise Institute.