Question from the blog: What is a trade deficit—and does it matter to my portfolio?
This question has been coming up a lot lately, and it’s no wonder. With Trump’s recent threats to impose tariffs on China and Canada in a trade war, trade deficits have been the talk of the town. Unfortunately, all of that talk has also been playing games with the stock market, causing fluctuations that don’t necessarily have anything to do with reality.
To explore how trade deficits and trade wars affect you, let’s start by looking at what is a trade deficit. Put simply; a trade deficit is an economic measure that indicates when a country’s imports exceed its exports. Sometimes referred to as a negative trade balance, a trade deficit represents an outflow of domestic currency to foreign markets.
How does it work? Here’s a great example plucked straight from the world of a Kaiser physician:
Let’s say there are two large HMOs—one is in Los Angeles, the other in Seattle. The HMOs have agreed to allow their members to receive health care at each other’s facilities as needed. To ensure everyone receives proper payment, at the end of each year the two accounting departments total up the bills, with the HMO in “deficit” agreeing to reimburse the other for services rendered.
In 2017, the number of LA members that received care from the Seattle HMO was more than double the number of Seattle members who received care in Los Angeles. That difference created a deficit for the Los Angeles HMO—resulting in a $7 million amount due.
Similarly, when we talk about trade deficits between countries, that deficit includes not just a single HMO or company, but the difference between all of the companies within one country vs. all companies within another. And when it comes to winners and losers, the metaphor still holds, though there can certainly be hundreds of permutations.
In the HMO example, the patients who received the healthcare, and the pharmaceutical companies who supplied medications are the clear winners, but most of the other winners and losers are less clear-cut. While the Seattle HMO is undoubtedly happy to receive a check for $7 million, the facility may have struggled to provide care to many out-of-town patients. Supply didn’t match demand. At the same time, the Los Angeles HMO will suffer from the loss of $7 million that was slated to pay for permanent staff required to take care of their members.
When this type of trade deficit occurs between countries, the government on the upside benefits from money moving through its economy and the tax revenue it receives on all sides of the transaction.
There are many very smart people on both sides of the argument of whether or not trade deficits matter. However, most economists feel that trade wars are a bad thing (trade wars essentially being when a country takes actions against another country to bring their trade into balance). Here are two very informative articles if you want to know more about the different sides of that discussion: https://www.wsj.com/articles/worry-about-the-trade-deficita-bit-1525215114 and https://www.cfr.org/backgrounder/us-trade-deficit-how-much-does-it-matter.
So by this point, the question of how this affects my portfolio needs to be answered. Historically, trade deficits have been more likely to cause short-term volatility in portfolios rather than long-term negative shocks. Making sure you have enough exposure to the world economy both from companies that do business overseas and companies that are based overseas will provide some protection from issues caused by trade deficits. If the market reacts negatively to trade news, it may also offer the opportunity to buy companies that do overseas business at lower prices. Long-term investors taking advantage of these “sales” on stock prices can lead to better returns in the long term.
Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Elevate and Eagle West are not affiliated with Cambridge.
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