For those who had a manufacturing job that has been off-shored to China, and are now cashiers at Wal-Mart, the trade deficit has worked against them—and to the degree they consume goods and services from fellow Americans, it has worked against the whole system. But if one’s job is stable, then it matters not whether your TV comes from China or America. If it came from China and it is just as good as an American one, or better, and cheaper, then you have more money for other things, and foreign trade has worked for you and the system.
The trade deficit means that dollars accumulate off-shore. Foreign factory owners cannot buy goods or pay expenses and salaries with dollars. They use their own currency for that, which they will have to exchange with dollars. If this continues at a high rate, dollars become plentiful and local money scarce. If the factory owner takes dollars to the money exchanger, and the exchanger gives back less and less of the local currency per dollar, then to maintain profits and pay expenses the price (in dollars) must be increased. So, say, as China accrues American currency, owners of Chinese factories would exchange dollars for local currency, which over time would rise in value against the dollar, and a new equilibrium is reached: Chinese TVs aren’t as cheap any more, Chinese workers would live better because their wages are more valuable, and manufacturing in America has a competitive chance. This is the easy way to resolve the trade deficit.
But problems happen when foreign currencies are pegged to the dollar. If Chinese currency is suppressed in value and does not float, then the prices of their TVs stay low indefinitely, and American plants close, and Chinese regulators are sitting on a massive pile of U.S. dollars. We have their goods, they have our money. Now what do they do? If they invest in U.S. T-Bills, then our government could initiate all manner of spending programs with little difficulty raising cash. Maybe—as the Fed dropped interest rates and treasuries followed suit—cash-laden foreign interests sought out mortgage-backed securities hoping for better returns. Maybe they just lent it right back to American consumers so we could continue to buy more and more.
I guess the idea would then have been you can extend credit forever. But you can’t. Americans have been lent more than they will be able to pay back, which will result in widespread defaults and foreclosures. We are left with a shell of an industrial base, and trading partners are left with unpaid debt. This is the hard way to resolve the trade deficit.