RDQ weekly economic update

The widening of the trade deficit in May was interpreted by some as a sign of a further slowdown in economic growth—possibly even corroborating double-dip fears. We strongly disagree.

Economists since Adam Smith (1776) and David Ricardo (1817) have argued against the mercantilist view that trade is a zero sum game and that only those with rising trade surpluses are winners. Ricardo’s theory of comparative advantage shows that all countries benefit from trade via specialization in producing goods that they have a relative advantage in producing.

Macroeconomists these days seem to focus on the trade balance as a measure of the addition to or the drag on GDP growth. We show that this analysis, though politically popular, is incorrect and that the rising trade deficit is a sign of both U.S. and global economic growth.

One particular sign of strength is the movement in capital goods imports and exports, which point to increasing investment spending (and likely rising expectations of future profits).

Movements in the dollar do not appear to explain movements in the trade deficit. From 2002 to 2008, for example, the foreign exchange value of the dollar fell sharply and the monthly trade gap worsened substantially.

In the wake of May’s trade report, bond yields backed up and the equity market rallied in the U.S. We think these trends will continue over the balance of the year.

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