Lecture: Trade Deficit & Capital Flow: Narrator: Listen to part of a lecture in an economics class. Professor: No doubt, you've been hearing a lot about how the United States has trade deficits with this country or that country. And in the news, they make it seem like it's such a terrible thing. Well, today we're going to set the record straight by looking at the big picture. Okay. So trade activities between countries are divided into two categories. One, the exchange of goods and services; and two, the exchange of capital. Ok, goods and services and capital. Now, one of the statistics used to measure international trade activities is net exports. Net exports is the difference in value between how much businesses in a country export and how much they import. We say the country's net exports are positive when it exports more goods and services than it imports. And a country's net exports are negative when its businesses import more goods and services than they export. Okay. Now, another word for a negative net export is trade deficit. So a country with a trade deficit imports more than it exports. It buys more than it sells. Typically, people view positive net exports as favorable and trade deficits, negative net exports, as unfavorable to a country. However, the idea that a trade surplus benefits a country more than a trade deficit is a fault feeling. It's simply not consistent with sound economic ideas and principles. That erroneous idea started in the 17th and 18th centuries with the mercantilists. Mercantilists believe in promoting exports, but restricting and regulating imports. So they treated a trade surplus as a good thing and a trade deficit as a bad thing. This policy still lingers in the minds of many people today. The fallacy arises from focusing on only one part of the trade activity, namely goods and services, rather than on the country's total international trade, including capital flows. And ... to keep things simple, when I refer to capital, I'm talking about money. To understand why we shouldn't conclude that trade deficits are by themselves a source of concern. We need to examine how our country's total international transactions are calculated. Okay? If the country runs a trade deficit, its exports of goods and services are not paying for its imports. What we're saying here is that when you run a trade deficit, that deficit must be financed it has to be paid for. To finance this trade deficit, a country must be a net importer of capital. Um, of money. So money in the form of investments comes into the country and makes up the difference in value between the exports and imports of goods and services. Oh, for example, when the United States finances other countries' trade deficits, it buys, for example, bonds and stocks in those countries. That would be a capital outflow, also referred to as a capital export, because the money is going out from the United States and going into another country. Now I mentioned stocks and bonds quickly. Stocks are issued by companies in order to raise money. Buying stocks, like buying a very small piece of a company, you actually become a part owner. And when the company is successful, then generally the value of the stock rises. Conversely, if the company does poorly, then the value of its stock can fall. When you purchase a bond, you're actually lending a company or even a government, you're lending them money. And the bond is the company or governments promise to pay you back the money you lent them plus interest at a specific time in the future. So for example, uh, if you purchase a government bond that matures in five years and has an interest rate of five percent, that means in five years, you would get back to your initial investment plus additional money in accumulated interest. So when the United States runs a trade deficit, we would expect that other countries would buy stocks, bonds, or other financial assets in the United States, and then there would be a capital inflow or capital import that makes up for the United States trade deficit. So any good international economist will tell you: do not view a trade deficit as a bad thing. Instead, look at the total transactions of capital as well as goods and services. When you evaluate any countries, international trade position.