Do you know what a trade deficit is? And if so, do you know how it affects the business of imports and exports? Many people do not understand trade deficits beyond what they hear politicians mention on the campaign trail. But rest assured they have a significant impact on international trade. In turn, they impact the economics of every American household.

Trade deficits are a product of two things: physical imports and exports and investments in domestic and foreign companies. Put them together and you have what economists refer to as the ‘balance of payments’. Ideally, trade works best when things are evenly balanced across the board. But as you know, most countries want the balance to tilt in their favor.

Trade Deficits Explained

Countries around the world are involved in importing and exporting. An individual country’s trade balance is a reflection of how much is being imported as opposed to exported. If import value is greater, a nation is said to have a trade deficit. That is pretty much it in terms of a basic definition.

U.S. exports for June 2021 stood at about $212 billion. Imports were just under $283 billion. Our trade deficit at the end of June was roughly $70 billion, meaning we imported the equivalent of $70 billion in goods over and above what we exported. The good news is that June’s numbers represented a 4.3% drop from the month before.

Trade Deficits and Investments

Trade deficits are not limited only to physical goods. They also relate to investments. Note that U.S. investors can put their money into both domestic and foreign companies. If investors are putting more money into foreign companies, they are contributing to the trade deficit. If they put more money into domestic companies, they are helping the country move toward a trade surplus.

Foreign vs. domestic investment comes into play when the government is calculating the balance of payments. In short, the balance of payments combines both investment and physical goods. With that said, let us discuss how all of this affects importers and exporters.

What’s Good for One Is Bad for the Other

In a perfect world, trade imbalances create winners and losers on both sides of the equation. Ohio-based Vigilant Global Trade Services likes to illustrate the principle using a scale. If you add weight to one side of the scale, it affects the other side. Though you might like to keep the scale in perfect balance, doing so is not as easy as it sounds.

A country with a trade surplus is exporting more than it imports. This is good for exporters in the sense that they are making more money. Not only are they supplying goods for domestic customers, but they are also sending goods to foreign customers. As a result, importers are at a disadvantage.

On the other hand, a trade deficit is more advantageous to importers. Importers are bringing more goods into the country than exporters are shipping out. That means U.S. customers are buying more overseas goods as compared to their domestic counterparts. This puts domestic manufacturers at a disadvantage.

Monetary Policy Is a Big Influence

The icing on the trade balance cake is government monetary policy. As you know, governments manipulate money supplies in order to achieve certain economic goals. Their manipulation directly impacts how people spend their money. In turn, consumer spending influences trade deficits.

In a perfect world, global trade and investments would be equally balanced among all participating countries. But this world is far from perfect. As a result, trade deficits and surpluses will always be in play.