Thread by @michaelxpettis

The U.S. trade deficit widened in September to a record $80.9 billion, driven by climbing demand for capital goods like computers and electric equipment and industrial supplies. wsj.com/articles/u-s-t… via @WSJ

2/12
“The trade deficit is being driven wider,” they say, “by shifting patterns of demand for the raw materials and inputs for American factories and retailers.”

But while this (circular) reasoning might have been less mistaken many decades ago, it simply isn’t true today.

3/12
Consider that changes in the trade deficit (or, more correctly, the current account deficit) are perfectly matched by opposite changes in the capital account surplus. If the US capital account consisted mainly of trade finance, and it was only the trade finance component...

4/12
that adjusted, then it might be less unreasonable to argue that changes in domestic demand components drove changes in the trade balance, which in turn drove changes in the capital account.

5/12
But in fact changes in the US capital account are driven by the many, complex decisions of foreign and American investors, which among other things are themselves affected by Fed policy and changes in foreign savings imbalances.

6/12
However if one acknowledges that capital flows to the US reflect foreign savings imbalances, which are largely independent of American trade finance needs, then how do we explain the fact that the capital and current accounts are always in perfect balance?

7/12
Either we must assume an astonishing set of coincidences at every point in time, or we must accept US trade deficits are at least partly determined by foreign savings imbalances.

8/12
The US cannot run a deficit unless the rest of the world simultaneously runs a trade surplus. To assume that both are driven primarily by incremental and independent changes in the components of US demand is, at best, obsolete.

9/12
Many American may find it horribly confusing to consider that the US economy, let alone the global economy, doesn’t just reflect the independent decisions of US consumers and businesses, but in fact in a globalized world it cannot, and doesn’t.

10/12
Consider just China, for example, in which as the consumption share of GDP declined in the past year, and investment did not rise fast enough to compensate, by definition it exported more of its savings abroad.

11/12
For well over a year I have been arguing that China’s supply-side response to a demand-side problem would result in a rising savings imbalance, which would most likely show up as larger Chinese trade surpluses and larger American trade deficits.

12/12
That seems clearly to be what happened. The point is that the US doesn’t determine global trade imbalances. It’s main role is to absorb them.