In all of the recent news dealing with US President Donald Trump and the world economy, the term “trade war” is being used a lot more than would normally be the case.  But what does this term actually mean? Who are the winners and who are the losers? Does a “trade” war resemble a military war in any way?

These are all important questions, and there is a lot at stake for the global economy.  This is why it is essential to have a strong sense of the goals that can be achieved (and ramifications that can be incurred) when the proposition of global tariffs becomes a reality.  

Imports vs. Exports

In any global trade discussion, it is important to make the distinction between imports (goods bought from foreign sources) and exports (goods sold to foreign sources).  The following list shows the largest national trading partners that have a relationship with the United States:

But what exactly is traded with these countries?  Here is the list of top 10 import product sectors that came into the United States in 2017.  We can see that roughly 50% of the exports that came into the United States last year included items like electrical machinery, computer equipment, vehicles and fuel-related commodities:

Next, we will look at the top 10 exports made by U.S. companies and sold to consumers in other countries:

Interestingly, we can see that many of these items are similar.  For example, electrical machinery and computer equipment are high on both lists.  But why would any country import an item that it can already produce?

The answer is as complex as each individual consumer.  It may be that U.S. consumers are not necessarily interested in all of the items produced by U.S. companies.  Foreign sources are often cheaper, and this type of product will be viewed as preferable for some consumer demographics.  But since not all U.S. consumers fall into this category, it is entirely plausible that some products will be bought domestically while others will need to be imported from foreign sources.

Trade Deficits

Since the nature of global trade is complex, it is important to understand the net differences between imports and exports at any given time because this is what allows us to identify trade imbalances within the global economy. 

In this chart, we can see that both imports and exports have been rising steadily since the early 1990s.  Perhaps more critical, however, is the difference between the import and export figures that are posted annually.  This difference is referred to as a trade “deficit” because the United States imports products more than it exports.

Over time, these types of deficits can weigh on an economy because it means that fewer jobs are required domestically.  More money is going out than coming in, and eventually, that can lead to sluggish performances in yearly GDP numbers.

Currency Values

Currency valuation is another factor that is of supreme importance whenever we are discussing the potential economic impact of a trade war.  The U.S. dollar is considered to be the world’s reserve currency, which essentially means that most trade is conducted in U.S. dollars and most central banks around the world have a large store.  We can track the value of the greenback against a broad basket of currencies using the U.S. dollar index (which is often associated with the market symbol DXY).   

It might sound counterintuitive, but weaker currency values actually strengthen the outlook for countries with a large trade imbalance (like the U.S.) because this means that domestically produced goods will be cheaper for foreign consumers (where currency values might be rising).  This is why many experts have actually argued for a weak-dollar policy as a means for correcting trade imbalances.

Will these policies be adopted by the current administration?  Only time will tell. But since trade issues are a never-ending pursuit, these are lessons that must be understood — no matter which political party is in office.