What is a “Trade Deficit”?
According to Investopedia: “A trade deficit is an economic measure of international trade in which a country’s imports exceed its exports. A trade deficit represents an outflow of domestic currency to foreign markets. It is also referred to as a negative balance of trade (BOT).”
Trade Deficit = Total Value of Imports > Total Value of Exports
So if the Balance of Trade is Negative i.e. Imports are greater than Exports a country will have a net outflow of currency and theoretically it will go broke. However, over the years the U.S. has been able to maintain a negative balance of trade by borrowing money from other countries i.e. selling them Treasury Bills, Bonds and Notes. So they give us money to buy stuff from them.
On March 27, CNBC said that “the U.S. trade deficit fell much more expected in January to $51.15 billion, from a forecast $57 billion. The decline of 14.6 percent represented the sharpest drop since March 2018…” You would think this would be good for our economy as we are producing more and borrowing less. But it could also mean that we are buying less because our buyers have less money to spend. Conventional wisdom says that a falling trade deficit is good for stocks.
There are many widely held beliefs about the stock market that are unverified, questionable or simply untrue. Even professional market observers often neglect to investigate these widely held beliefs for themselves — and their clients. Consider the claim that a falling trade deficit is good for stocks, and vice versa. In this article from Elliott Wave International they look at the relationship between a falling trade deficit and the stock market. ~Tim McMahon, editor
Falling Trade Deficit is Good for Stocks: True or False?
By Elliott Wave International
A common claim from economic and stock market observers is that a rising trade deficit is injurious to the economy — hence, bearish for stocks. On the other hand, a falling trade deficit is commonly believed to be bullish for stocks.
Sounds like common sense, but the price action of the main stock indexes often defy reason.
For example, on March 27, CNBC reported, “The U.S. trade deficit fell much more than expected in January to $51.15 billion, from a forecast $57 billion. The decline of 14.6 percent represented the sharpest drop since March 2018… .” Yet on the day the news was released, the main U.S. stock indexes closed lower.
Over the years, countless economists and investors have been baffled when the stock market has risen on bad news and fallen when the news was good. This has happened time and time again with news regarding the expansion or contraction of the trade deficit.
Consider the following news items from the past four decades and contextual comments in brackets (courtesy of Robert Prechter’s 2017 book The Socionomic Theory of Finance):
March 28, 1981
The Commerce Department… reported the nation’s balance of trade deficit had improved in February. [The second of back-to-back recessions began just five months later.]
March 1, 1984
“… the trade deficit is an economic disaster,” said [a] chief economist. [An eight-year boom was just getting going.]
April 12, 1985
The secretary of state said, “We can break the back of the trade deficit only through…a stronger worldwide recovery….” [Precisely the opposite was true; the trade deficit rose during the strong worldwide recovery.]
May 26, 1990
The better-than-expected trade performance sent many economists scurrying to revise their trade forecasts. [A recession started a month later.]
February 22, 2002
The nation’s trade deficit narrowed by 11.4 percent in December. [The stock market was peaking and collapsed to new lows in October.]
February 15, 2008
[A chief economist] said that the smaller December trade deficit will help to boost overall economic growth. [The second-worst financial crash and economic contraction in a hundred years were already underway.]
And, on July 14, 2010, USA Today said:
Rising trade deficit could drag down U.S. recovery.
But, as we know, the economic recovery continued.
The below chart and commentary provide even more evidence.
As published in The Socionomic Theory of Finance
The chart reveals that had economists reversed their statements and expressed relief whenever the trade deficit began to expand and concern whenever it began to shrink, they would have quite accurately negotiated the ups and downs of the stock market and the economy over the past 40 years. The relationship, if there is one, is precisely the opposite of the one they believe is there. Over the span of these data, there has been a consistently positive–not negative–correlation among the stock market, the economy and the trade deficit.
The trade deficit’s widely presumed effect is 100% myth.
This is just one misconception in a long list of market myths… Do earnings really drive stock prices? Can the FDIC actually protect you? Is portfolio diversification a smart move? Read our free report “Market Myths Exposed“ now and find out whether your portfolio is built on flawed foundations.
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