Our nation forged its affluence and influence on trade. As a colony, our value to its then-Motherland was our ability to provide England with raw materials, and offer a ready market for its finished goods. In the era post-Reconstruction, the Gilded Era provided a half century of manufacturing growth that allowed the United States to overtake the United Kingdom as the dominant world economy. 

Things were different then. Almost all of our nation’s production was in the tradable products of agriculture and manufacturing. Now, these two sectors combined constitute less than a third of our production. 

Instead, our economy has been redesigned around domestic consumption, primarily of services. Some of these services can be traded internationally. For instance, the motion picture and digital content industries are significant, as are some parts of the financial sector. Even tourism is exportable. When one from another country visits here, that is an export, just as our travels to other countries represent the importation of tourism services. But, you can’t export a haircut or a nice meal at a restaurant. 

When movement of funds across borders primarily served the import-export sectors, our exchange rate reflected the ratio of how much we sell abroad compared to how much other countries purchase from us. A high export/import ratio created more demand for our dollars than our demand for our trading partners’ currencies, and hence increased our exchange rate. 

In that era, the exchange rate was a measure of economic success. Our nationalistic pride in a strong exchange rate remains an artifact of that sentiment. This is vastly different from some of our export-oriented trading partners. To them, a strong exchange rate means their products are relatively expensive in international markets, and hence the demand for their exports is weak. When one depends on international trade, such as Canada and Australia, too strong an exchange rate is not an advantage. 

Here’s where the United States has differentiated itself. Our expanding financial and asset markets are now equally significant in international trade as our goods markets. 

To see how, let’s track a typical exchange between Japan and the United States back when Japan was the world’s number two economy and our second largest trading partner (after the perennial favorite, Canada). 

Back in the 1980s, the U.S. was reeling from the aftershocks of the OPEC oil embargo more than a decade earlier. The major big ticket traded goods from Japan were automobiles. The Japanese, a resource-poor and population-dense nation without a domestic oil supply, had been building small and fuel efficient cars for decades. The United States had been producing bigger and bigger cars for even longer. That history of automaking bred a certain Michigan arrogance that manifested itself in statements like “What’s good for GM is good for the nation.”

Well, with oil prices doubling and quadrupling, Americans demanded less gas-thirsty vehicles. The best Detroit could come up with, after their typical years upon years of product development, were Ford Pintos and AMC Gremlins. We all know how well that worked out, especially for AMC. Some of you may be asking “What is an AMC”? Exactly. 

Meanwhile, Japan was exporting as many Honda Civics and Toyota Corollas as it could muster. They were selling like hotcakes. Our response was the Chrysler K-car. Again, what is that? 

Each month, we were sending billions of dollars over to Japan, to be converted to yen to purchase Japanese products. It is ironic that just a couple of decades earlier, “Made in Japan” was not a complimentary term. But, we taught them well. The Japanese absorbed every leading management and industrial engineering theory, most of which originated in the United States, but were not adopted here because, well, we’re GM. 

By the mid-1980s, we were buying so many Civics and Sony Walkmen that those American dollars started to accumulate. The Japanese did not want to repatriate them to buy our K-cars, so they instead sent them back to buy our companies and buildings. Motion picture studios, Manhattan properties, and many in between became Japan-owned. The Japanese also produced more of their cars in the U.S. as well so that the immediate movement of American dollars to Japan could be avoided. 

This allowed for asset purchases by Japan, OPEC nations, and others, to offset our purchases of commodities from them. American asset purchases by foreigners balanced our trade deficit, the difference between our goods and services imports over exports, to ensure the U.S. dollar remained strong. 

The net result now is that the U.S. dollar remains strong even though the pace of our trade deficit last month equated to a mismatch of a trillion dollars per year. Our Balance of Trade is in deficit because we sell a trillion dollars less of goods and services to others than they buy from us, but that difference is made up by a trillion dollar Balance of Capital Surplus of net U.S. asset purchases per year by others. 

So, there is no real problem with trade once we include the selling off of American assets, at least for now. There will be problems once these asset purchases, of American companies, stock, real estate, Treasury bonds, etc., result in dividends and profits sent abroad. Until that becomes problematic, we can remain fat, dumb, and happy. 

Now, China has replaced Japan as our largest creditor as they buy more of America rather than American goods than we purchase of China’s goods. The Chinese are not interested in our real estate or corporate stock. They are content to buy our long term government debt. Borrowing from the Chinese to cover our federal budget deficits offsets our trade deficit with them. Economists call this the ‘twin deficits’. Like a codependent couple, they fuel each other. 

So long as we understand our trillion dollar trade deficit is just the other side of a trillion dollars of American asset purchases, everything is fine. Once we realize that asset purchases come at a price of profits, dividends, rents, and coupon payments sent increasingly abroad, our short term complacency may result in long term consternation. 

Of course, as always, the solution is complex. It requires the United States to have an industrial and perhaps an energy policy that allows our country to reattain world leadership in manufacturing, product development, R&D, and innovation. And it requires the US to pay-as-we-go instead of runups of our national debt. These dimensions we always thought we managed well without a plan, simply based on American dynamism and exceptionalism. Well, others have been watching, and now know how to do what we did and at times do it better than us.

Indeed, if one wants to see the world’s leading edge in nuclear fission and fusion, modern robotic manufacturing, energy storage through battery production and pumped hydro, and electric vehicle manufacturing, we need not look at the country that invented these technologies. Now, we look to China, with their growing entrepreneurial spirit, the graduation of vastly more engineers each year, some of whom we taught well, a large amount of ready financial capital, and an absolute thirst to overtake the U.S. as the world’s leading economy, likely later this decade. 

We may be suffering the Winner’s Curse now. But, other nations are watching, and even at times imitating, our every success, with a drive so acute that they may even be willing to sacrifice political freedom for economic dominance. 

It will be interesting to see how we navigate all this. To see the recent trade figures released that reveal a trillion dollar trade deficit for the first time, and to hear not a whimper makes me wonder.