Our North America economist Marcos Carias explains the balance of payments and why the trade deficit is only half the story. Follow along to understand just how delicate the U.S. trade situation is and the data that could define where it's headed.
It’s safe to say by now that April 2025 will go down as one of the most consequential months in recent memory, at least for global economics and trade. But the casual observer may not fully appreciate just why.
Survey data tells us that the average American household understands perfectly well that tariffs will lead to more expensive goods, and the jump in retail sales we saw in the March tells us they are acting on that knowledge by front-loading their spending while things are still relatively cheap. Firms seem to understand that, given the unprecedented levels of policy uncertainty, this is not the best time to be making big moves, and so investment is expected to fall. Survey indicators conducted by the regional Fed offices show future capital expenditure intentions trending downward since January.
But when it comes to financial markets, what we’ve been seeing is a bit more unusual and concerning:
- Typically, if investors believe tariffs are creating a successful incentive to purchase domestically manufactured goods from a country you’d expect them to increase their exposure to companies based in that country. That’s not happening here. Instead, equity markets have suffered intense volatility, alternating between record-breaking corrections and rallying at the slightest hint that the Trump administration intends to walk back tariffs.
- Tariffs, to the extent that they make Americans use dollars to pay a tax to the U.S. government rather than exchange them for foreign goods, should make the U.S. dollar appreciate. You would therefore expect the greenback to rise against foreign currencies. Instead, the dollarhas lost 10% of its value against other major currencies.
- When you have a widespread correction across risky assets, such as stocks, you usually see investors flocking into safe haven assets like U.S. treasuries. Instead, we’ve been seeing acute rises in treasury yields, suggesting investors are actually flowing out of treasuries and not into them.
Such patterns suggest that investors are taking their money out of U.S. assets in large enough numbers to have commentators questioning the safe haven quality of treasuries and the reserve currency status of the dollar. This is not a new conversation, but one that is typically set at some theoretical, unspecified point in the future.
This is the first time I’ve seen this conversation discussed by serious people as an event that could be unfolding in real-time. I’m not one to keep the reader in suspense, so I want to say from the open that I don’t think we’re far enough down this road to declare the imminent dethroning of the dollar. But if the dollar system does break down in the forthcoming years, future historians might point to this as the moment it all started.
The balance of payments and why the trade deficit is only half the story
We are going to dust off some concepts from Macroeconomics 101. These tools are important to understanding how delicate the current trade situation is. These terms are not always explained in depth, so bear with me or skip ahead if your open economy macro is still fresh.
America’s trade deficit is big and significant. While the average person may not think about this often, it is important to understand our current trade environment and the perception of the current administration. Running a trade deficit means that the U.S. spends more money buying stuff from the rest of the world (RoW) than it makes from selling stuff to it. This has led to some political players believing America is getting “ripped off” by engaging in international trade. But this isn’t exactly the whole story.
Trade in goods and services is not the only way of making (or losing) money when interacting with foreign countries. Another way is the selling and purchasing of financial assets, such as bonds, stocks, real estate and factories. The U.S. runs a chronic surplus on financial assets vis-à-vis the RoW. This means each year, more money flows into the U.S. from foreigners buying assets than the money flows out from Americans buying assets abroad.
You can think about these cross-border flows of money as the U.S. keeping two parallel accounting ledgers: the current account (which mostly consists of trade in goods and services) and the financial account1. Taken together, they form what we call the balance of payments (BoP), or the full accounting of wealth flowing in and out of the country, by any means.
Once you account for both trade and finance ledgers in the U.S., you find that they cancel each other out. That means, for every dollar that flows out because of the deficit in trade, a dollar flows in from the surplus in financial transactions.
This is not a curious coincidence but one built by design.
You might wonder, where does the U.S. get the money to buy more than it sells to the RoW, year in and year out? Easy. The U.S. government raises debt from foreign investors, then distributes to households and firms in the form of tax cuts, welfare and public services. U.S. corporations raise foreign equity, then distribute it to workers in the form of wages or directly import the machines and materials necessary to expand production capacity. As I explained some months ago, this is the surplus of purchasing power afforded to the U.S. in exchange for emitting the currency that the world wants to use and hold. The U.S. capacity to attract foreign capital, the current account deficits, and the preeminence of the U.S. dollar are all inextricably linked and pillars of U.S. prosperity.
Why should we care about the current account deficit being the mirror image of the financial account surplus? Imagine for a moment that the flow of money from foreign investors to the U.S. government were to stop or reverse (the technical term for this is “capital flight”). When this occurs, we expect treasury yields would go up, forcing the government into austerity if it wishes to avoid a sovereign default. Austerity means a combination of higher taxes and lower spending, meaning less purchasing power for households and firms, less demand, and less imports. Your shrinking financial surplus would be mirrored by a shrinking trade deficit, because your economy would be in recession, or at least a slowdown. Not good. And not unimaginable, either. At the worst, these episodes can spiral into a full-blown financial crisis and have occurred in modern times in Mexico (’94), Thailand (’97), and Greece (2010). They are known in the business as balance of payments crises, or currency crises if they involve large currency depreciation. Recovery from such scenarios is long and hard.
1Also referred to as the “capital account” in some writings, especially older ones.
So, are we headed for a BoP crisis?
Not necessarily. The bad news is that the combination of trends explained above (plunging dollar and equities, rising yields) are precocious symptoms of capital flight. Capital flight typically happens to countries when foreign investors have a sudden loss of confidence in the quality of governance and economic policies in the debtor country.
The good news is that to declare a BoP / currency crisis we would need these trends to hold for longer and become stronger. A classic rule of thumb economists use to identify these episodes is “has exchange rate depreciated by more than 25% over the year?” Fun fact: it typically goes without saying that what we mean here is “25% against the dollar.” That we’re asking this question with the dollar as the weakening currency is another sign of just what a strange moment this is.
In any case, the dollar is down 10% against the euro since its mid-January peak. So, as I said, we aren’t quite in BoP territory just yet but we’re also barely a quarter into the year. We can hope that the White House is mostly done with the most destabilizing elements of the trade agenda, meaning that we’re past “peak tariffs”; and that negotiations will lead to a tariff easing cycle. I suspect that to take us out of the high uncertainty, low credibility regime we’re in we would need something like the President declaring trade war victory; something to give us confidence that the last couple of months were a one-off, and not a new status quo.
Bottom line, damage control remains squarely in the hands of U.S. policymakers: the executive branch and the legislative branch that can, if it chooses to, act as a check on it. Only in the last few days, President Trump manifested his wish that US-China tariff rates go down substantially. This conciliatory turn has been viewed favorably, yet the frequency and intensity with which the White House changes its discourse makes it very hard for market participants to make long-term plans, and for words to have credibility. A crash is not a foregone conclusion, but the bullish “Trump Trade” of the post-election months has given way to the bearish “Sell America Trade”.
Marcos Carias is a Coface economist for the North America region. He has a PhD in Economics from the University of Bordeaux in France, and provides frequent country risk monitoring and macroeconomic forecasts for the U.S., Canada and Mexico. For more economic insights, follow Marcos on LinkedIn.
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