Against
Trade deficits were originally opposed by the mercantilists of the 18th century, who saw it as weakening the country.
One view opposes long run trade deficits and outsourcing for the sake of labor arbitrage to obtain cheap labor as an example of absolute advantage which does not produce mutual gain, and not an example of comparative advantage which does. Some economists and the Congressional Budget Office claim that GDP and employment . An economy means increased demand for domestic and foreign products. This promotes foreign and domestic businesses seeking to capitalize on demand. Foreign credit sources have to invest in a growing nation's capital. Thus, GDP growth can be a trade deficit.
Some contend effects of deficits are detrimental. Since the stagflation, the U.S. economy has been characterized by slower growth. In 1985, the U.S. began its growing trade deficit with China. In 2006, the primary economic concerns have centered around: high national debt ($9 trillion), high corporate debt ($9 trillion), high mortgage debt ($9 trillion), high unfunded Medicare liability ($30 trillion), high unfunded Social Security liability ($12 trillion), high external debt (amount owed to foreign lenders) and a serious deterioration in the United States net international investment position (NIIP) (-24% of GDP),trade deficits, and a rise in illegal immigration. These issues have raised concerns among economists and unfunded liabilities were mentioned as a serious problem facing the United States in the President's 2006 State of the Union address
Large inequalities imply problems. Exchange rates have been pegged at levels preventing correction of a trade imbalance, such as the pegged Chinese currency.
The trade deficit must be foreign income or transfers, or a capital account surplus. This takes into account investment and purchases of stocks, bonds etc. Foreign liabilities tend to exacerbate already-extant savings-investment issues.
Pro
Those in favor of the deficit point to this as the source. Buyers in the receiving country send the money back. A firm in America sends dollars for Brazilian sugarcane, and the Brazilian receivers use the money to buy stock in an American company. Although this is a form of capital account reinvestment, it is not a liability on anyone in America.
Such payments to foreigners have intergenerational effects: by shifting the consumption schedule over time, some generations may gain and others lose . However, a trade deficit may incur consumption in the future if it is financed by profitable domestic investment, in excess of that paid on the net foreign debts. Similarly, an excess on the current account shifts consumption to future generations, unless it raises the value of the currency, detering foriegn investment.
However, trade inequalities are not natural given differences in productivity and consumption preferences. Trade deficits have often been associated with international competitiveness. Trade surpluses have been associated with policies that skew a country's activity towards externalities, resulting in lower standards. An example of an economy which has had a positive balance of payments was Japan in the 1990s. The positive balance was partly the result of protectionist measures that brought excessive profits to Japanese exporters.[citation needed]
Milton Friedman has famously argued that trade deficits are not important, as high exports will raise the value of the currency, reducing aforementioned exports, and visa versa for imports, thus naturally removing trade deficits not due to investment. This opinion is shared by David Friedman, who has said that they are 'fossil economics', based on ideas obsolete since David Ricardo.
Milton Friedman on trade deficits
Milton Friedman, the Nobel Prize-winning economist and father of Monetarism, argued that many of the fears of trade deficits are unfair criticisms in an attempt to push macroeconomic policies favorable to industries. He stated that these deficits are not harmful to the country as the currency always comes back to the country of origin in some form or another (country A sells to country B, country B sells to country C who buys from country A, but the trade deficit only includes A and B). In fact, in his view, the "worst case scenario" of the currency never returning to the country of origin was actually the best possible outcome: the country actually purchased its goods by exchanging them for pieces of cheaply-made paper. As Friedman put it, this would be the same result as if the exporting country burned the dollars it earned, never returning it to market circulation.
Critics that Friedman's argument is equivalent to saying that it doesn't matter if you get indebted, because eventually you will have to pay the money back. The obvious counterargument is that once a significant debt has been accumulated, paying it back may be painful. Friedman's supporters retort that when the money returns, the demand for foreign currency will make the exchange rate better for trade deficit country.
Friedman's view is seen by as ignoring the intergenerational or long run consequences of deficits, low savings, and borrowing to fund consumption. If country A has a trade deficit because of large imports of consumer goods, other countries accumulate cash from country A. That money can be used to purchase existing investment assets and government bonds within country A. As a result, the return from those assets will accrue not to citizens of country A but to foreigners. The consumption standard of future generations in country A may therefore potentially decline as a result of the deficit. In particular, Americans are increasingly paying taxes to finance the interest on federal bonds held by foreigners. However, a criticism of this argument notes that all transactions are win-win. In the case of foreign investment in American assets, it helps fuel American economic growth and keeps US interest rates low. This argument is more appealing in the case of foreign direct investment, and less obvious when foreigners simply purchase the existing stock of assets.
Friedman also believed that deficits would be corrected by free markets as floating currency rates rise or fall with time to encourage or discourage imports in favor of the exports, reversing again in favor of imports as the currency gains strength. A potential difficulty however is that currency markets in the real world are far from completely free, with government and central banks being major players, and this is unlikely to change within the foreseeable future. Nevertheless, recent developments have shown that the global economy is undergoing a fundamental shift. For many years the U.S. has borrowed and bought while in general, the rest of the world has lent and sold. However, as Friedman predicted, this paradigm appears to be changing.
As of October 2007, the U.S. dollar has grown weaker against the euro, British pound, and many other currencies. For instance, the euro hit $1.42 in October 2007, the strongest it has been since its birth in 1999. Against this backdrop, American exporters are finding quite favorable overseas markets for their products and U.S. consumers are responding to their general housing slowdown by slowing their spending. Furthermore, China, the Middle East, central Europe and Africa are absorbing more of the world's imports which in the end may result in a world economy that is more evenly balanced. All of this could well add up to a major readjustment of the U.S. trade deficit, which as a percentage of GDP, began in 1991.
Friedman and other economists have also pointed out that a large trade deficit (importation of goods) signals that the country's currency is strong and desirable. To Friedman, a trade deficit simply meant that consumers had opportunity to purchase and enjoy more goods at lower prices; conversely, a trade surplus implied that a country was exporting goods its own citizens did not get to consume or enjoy, while paying high prices for the goods they actually received.
Perhaps most significantly, Friedman contended strongly that the current structure of the balance of payments is misleading. In an interview with Charlie Rose, he stated that "on the books" the US is a net borrower of funds, using those funds to pay for goods and services. He pointed to the income receipts and payments showing that the US pays almost the same amount as it receives: thus, U.S. citizens are paying lower prices than foreigners for capital assets to exchange roughly the same amount of income. The reasons why the U.S. (and UK) appear to earn a higher rate of return on their foreign assets than they pay on their foreign liabilities are not clearly understood. An important contributing factor is that the U.S. has investment primarily in stocks abroad, while foreigners have invested heavily in debt instruments, such as U.S. government bonds Other reports contend that U.S. net foreign income has deteriorated, and appears set to stay in deficit in the future .
Friedman presented his analysis of the balance of trade in Free to Choose, widely considered his most significant popular work
