Originally written on 4/8/2025

President Trump’s tariffs, announced on April 2, 2025, have rocked financial markets and the world economy. There is so much to examine we hardly know where to begin. We will focus on some fundamental facts about the Balance of Payments. 

The Balance of Payments is an accounting device used to track a nation’s financial/economic interactions with the rest of the world. Its basic form has two major components: the Current Account and the Capital Account. In the simplest terms, the Current Account is the balance of trade in goods and services, and the Capital Account is the balance of trade in financial assets. A nation’s balance on its Current Account is offset by an equal and opposite balance on its Capital Account.  

Suppose the US sells $3 trillion of goods and services to the rest of the world and buys $4 trillion of goods and services from the rest of the world. In other words, the USA has a trade deficit of $1 trillion, where US imports are $1 trillion more than exports, which creates a Current Account deficit of $1 trillion and a $1 trillion Capital Account surplus.  

The $1 trillion Capital Account surplus is because the US had net imports of $1 trillion, and in return, the rest of the world acquired $1 trillion in claims on US goods and services that can be redeemed in the future. The $1 trillion is an asset to the rest of the world. The Balance of Payments equals zero since the Current Account deficit equals the Capital Account surplus.   

From the above example, it is easy to think that the Capital Account balance is a passive by-product of the Current Account balance. But that is not necessarily the case. Typically, foreigners do not hold the excess dollars earned as cash. At the very least, they deposit them in dollar bank accounts or US government bonds to earn interest. They also use the dollars to buy US-based portfolio assets, such as US common stocks, businesses in the US, and US real estate. Foreign investment in the US increases the US Capital Account balance and decreases the Current Account balance. Indeed, the Balance of Payments can be driven by the desire of foreigners to buy US assets, with the trade balance being an afterthought. Did the trade deficit cause foreign investment in the US, or did foreign investment in the US cause the trade deficit? We’ll leave that to another column.