Put simply, a country running a trade deficit shows that it consumes more goods and services than is supplied by its productive capacities. Conversely, a country with a trade surplus produces more goods and services than is consumed in its domestic markets.

The next step is to see what that does to international business transactions, summarized in a set of accounts called balance of payments.

The key word – or a concept – here is the balance, because in deficit and surplus countries the balance of payments must balance – i.e., it must be equal to zero except, as accountants say, for statistical discrepancies.

There are two accounts in each country’s balance sheet. Trade in goods and services with abroad is recorded in the current account, while all transborder financial capital movements are posted to the capital account.

The deficit incurred on current international transactions must be financed by an equal inflow of short- or long-term foreign capital because the balance of payments has to balance: the sum of current and capital accounts must be equal to zero.

And that’s where issues arise implying questions of national security.

Take trade deficits seriously

The first, and the obvious question is the level and the composition of that foreign debt. Most often, a level of the current account deficit of up to 3 percent of GDP is considered relatively “safe.” And the more the capital imports to finance that is long term the better. Short-term liabilities, or “hot money inflows,” are dangerous because those are volatile capital movements.

Problems also arise because foreign trade deficits are rarely, if ever, driven down until a financial crisis makes that imperative. The crisis is hastened by the country’s declining credit rating because trade deficits are often coupled with high inflation, fiscal deficits and rising public debt.

So, at some point, trade adjustments become inevitable, triggering growth recessions because of rising interest rates, government spending cuts and higher taxes. That lowers imports and leads to more balanced external accounts.

Trade surplus countries have no such pressures, even though the original (Bretton Woods) international monetary system imposed symmetric obligations for deficit and surplus countries to maintain balanced trade accounts.

That symmetry was an elusive objective because financial crises forced deficit countries into debilitating recessions by withdrawing funds or sharply raising the cost of funds. That was, and still is, the mechanism for restoring the demand and supply balances in deficit countries’ labor and product markets.

Surplus countries are exposed to political pressures for being “beggar thy neighbor” traders, but, generally, they brush that off unless they are forced to stimulate domestic demand to raise employment and household incomes.

U.S. cannot ignore large trade imbalances

Germany is a good example of that. With current account surpluses of 6% of GDP, and an unemployment rate of nearly 4%, the German economy has been in recession over the last three years. The chancellor’s approval rating is sinking to 22%, with only 15% of respondents thinking that he can address the country’s problems, and about 50% expecting a demise of his government before next elections.

Two-thirds of German trade surpluses come from the rest of the E.U. That drags down the E.U. to a stagnating growth path below 1%. German surpluses also represent most of E.U. trade surpluses of about 3% of GDP.

What that says is that Germany and the entire European trading bloc of 450 million people live off their main trade partners.

That’s the problem the U.S. is facing as the world’s largest buyer of E.U.’s goods and services. America’s European imports in the first nine months of this year came in at $494 billion, a 10% increase from the year earlier, pushing up the American trade deficit with the E.U. by 5.4% over the same period.

The E.U. accounts for America’s second largest trade deficit on record, after the combined deficit with Canada and Mexico. And the irony is that Washington’s very rich trade partner lives off the U.S. and demands security protection on top of that.

Meanwhile, those trade deficits are a significant drag on American economic growth. In the first two quarters of this year, the U.S. trade deficit shaved off 0.8% from America’s GDP growth.

That means that the U.S. contributed to the rest of the world 0.8% of its domestic demand. But to finance the resulting current account deficit -- running this year at an annual rate of $1.4 trillion (up 22.3% from 2024) -- the U.S. will have to import foreign savings of the same amount to balance its external trade accounts.

Is it any wonder that President Trump is screaming of a “rip-off” as American foreign liabilities are soaring at an annual rate of $3 trillion to stand at the end of last June at a whopping $26.1 trillion.