Remembering the Capital Account Surplus

The poet Alfred Lord Tennyson reminded us to be careful about language:  “For words, like nature, half reveal and half conceal the truth within.” Behavioral economists have shown that patients will embrace a surgical procedure with an 80% chance of success, but balk at a 20% chance of failure. Likewise, is a deficit a bad thing? For a diet, a caloric deficit is a good thing; for a patient wasting away in a hospital bed, it’s a bad thing.

A friend once quipped that the trade deficit would stop being a problem the instant we stopped measuring it. Indeed, as so many economists have demonstrated (especially in the past few months), a trade deficit simply means a country is buying more from its trade partner than the trade partner is buying. I run a trade deficit with my grocer and my dentist without any expectation that either will purchase anything I make (or, for that matter, any of my economics lectures). Or, as Frédéric Bastiat asked rhetorically in an essay on More Reciprocity:  

In practice, is there one trading operation in a hundred, a thousand, or perhaps even ten thousand that is a direct exchange of one product for another? Since money first came into the world, has any farmer ever said to himself: “I want to buy shoes, hats, advice, and lessons only from a shoemaker, milliner, lawyer, or teacher who will buy wheat from me for exactly the equivalent value”? And why would nations impose this obstacle on themselves?

The word “deficit” is thus negatively value-laden. In the Keynesian hydraulic system, taxes, imports, and savings are considered to be leakages from the economy, as they are resources not spent on Lord Keynes’s beloved consumption. In the Keynesian vision, these leakages return to the economy in the form of government spending, income from exports, and investment. Still, the very language of leakages and the first violin role of aggregate demand (and thus consumption) evince a bias against the leakages. In this piece, I will set aside taxes and government spending and focus instead on the foreign exchange and financial markets.

For all the worry with which economists have (rightly) greeted tariffs, there has been precious little discussion of capital accounts. The most recent commentary on the subject in “our circles” seems to come from my friend Ben Powell, in these very pages, as far back as October 2006. In that article,  Dr. Powell explained how a trade deficit is, by definition, a capital account surplus:

The balance of payments accounting system has two major accounts: the current account and the capital account. The current account mainly measures trade in goods and services. The capital account mainly measures trade in assets. A trade deficit refers only to the current account balance.

Balance of payments accounting is done with a double-entry system of debits and credits. Each transaction involves both a debit and a credit.

Put simply, if you buy something from a foreigner, you must pay him—a debit is entered. Then the foreigner must somehow spend or save your payment—a credit is entered. When all credits and debits are added up, the entire accounting system must balance: The current account balance plus the capital account balance must sum to zero. Hence, a current account (trade) deficit implies a capital account surplus.

Why does all this matter today? First, because a trade (or current account) deficit doesn’t matter—it simply shows that the U.S., as the world’s biggest economy and one of the wealthiest, is buying more from foreign countries than foreign countries buy from the U.S.  And second, because the language is obfuscatory:  just like patients who struggle with elementary probability theory, the very language is biased. Surely, a deficit must be bad, right? But a trade deficit is not bad and a capital account surplus is cause for celebration.

In 2024, the U.S. had a trade deficit of about $900 billion. By definition, this means the U.S. had a capital account surplus of $900 billion. That’s almost a trillion dollars that foreigners chose to invest in the U.S. economy, further fueling American innovation, capital accumulation, and job creation.  

Just as the U.S. is the biggest economy in the world, it is also the most attractive for foreign investors, and this is for many reasons. The U.S. has a strong tradition of rule of law and protection of property rights. It has deep and liquid financial markets, so deep, in fact, that the U.S. alone has the largest share of the world’s stocks; it accounts for half the value of the world’s stock capitalization.  It’s also easier for Americans to buy stocks directly or through mutual funds.  Fully 55% of Americans own stock, as opposed to 33% of Britons, 15% of French and Japanese, 14% of Germans and Dutch, 7% of Italians and Chinese, 6% of Indians, and 5% of Belgians. Add to that the dollar’s role as the international currency, and it’s a small wonder that almost a trillion dollars’ worth of foreign investment flowed into the country last year.

The depths of economic ignorance are staggering. American policymakers who are pushing for tariffs would not just diminish trade but also capital inflows and long-term investment in the American economy.   The international sensation statistician Thomas Piketty has recently argued that Europe needs to channel its savings into internal investment rather than U.S. capital markets without considering that investors respond to risk and reward rather than the injunctions of pundits.

Beyond tariffs, other threats to American domination of capital markets loom; recent attacks on the rule of law might dissuade foreign investors and continued bipartisan flippancy about the U.S. national debt of $36 trillion will eventually put pressure on U.S. government bonds, with possible spillover effects into other parts of overall capital markets. My colleague Will Luther likes to say that the U.S. economy is the world’s cleanest dirty shirt. There is currently no viable alternative to U.S. financial markets or to the dollar as the world’s reserve currency. But that might not last forever, and foolish policies won’t help.