America’s trade deficit is shrinking, so why are economists worried?

The U.S. trade deficit with the rest of the world fell by $6.4 billion to $58.3 billion in August—the lowest in almost three years. Economists warn this could spell trouble for an economy that heavily relies on consumer spending.

According to the Census Bureau, imports fell by 0.7% in August to $314.3 billion, while exports increased by 1.6% to $256 billion. Year-to-date, the deficit is down 20.7% compared to the same period in 2022.

Some economists consider large trade deficits to be undesirable because they signal a diminishing manufacturing base at home, which has adverse effects on employment and economic growth.

Others believe a large deficit signals that consumers and businesses are purchasing more goods and services from abroad, which is a net positive for the economy.

In the context of today’s America, a shrinking deficit looks good at the surface—but the devil is in the details.

A double-edged sword

Because of how GDP growth is calculated, declining imports and a smaller trade deficit can make the economy appear stronger.

That’s why economists quickly upgraded their estimates of third-quarter GDP growth after the Census Bureau released its trade figures last week.

“The lower-than-expected deficit in goods and services for August will help add to an already strong quarter,” chief economist Eugene Aleman of Raymond James told MarketWatch.

"The tightening of the trade balance should boost GDP as foreign consumers buy more American goods and as the manufacturing industry comes off its bottom,” Citigroup economist Veronica Clark told Reuters.

After the release, Goldman Sachs boosted its third-quarter GDP estimate by 0.3 percentage points to a 3.7% annualized pace.

But part of the decline in imports could be due to weaker demand from consumers and businesses—a trend economists flagged earlier this year amid rising interest rates.

According to the Census Bureau’s data, the U.S. imported fewer cell phones and computer chips in August.

“Weakening consumer demand for goods and retreating inventory growth by businesses have softened imports this year, while exports continue to trend downward as the global economic backdrop softens,” according to Matthew Martin, a U.S. economist at Oxford Economics.

“We expect depressed trade flows through the remainder of the year.”

Consumer spending: The engine of the U.S. economy

A broader view of trade deficits taken by German economist Andreas Freytag and Cato Institute scholar Daniel Griswold shows the importance of imports for the U.S. economy.

“The U.S. trade deficit is a misunderstood symbol of U.S. economic strength and influence in the world,” they wrote. “[T]he trade deficit is driven by a persistent net inflow of foreign capital, which reduces interest rates and fuels economic output."

Imports also play a direct role in fueling consumer spending, which accounts for more than two-thirds of U.S. GDP.

"[I]mports increase consumer choice, and help keep prices low raising the purchasing power for consumers,” according to the Office of the United States Trade Representative. “Imports also provide high-quality inputs for American businesses, helping companies and their U.S. employees become or remain highly competitive in both domestic and foreign markets.”

Data on consumer spending shows that households remain resilient in the face of rising interest rates and higher debt servicing costs. According to the Department of Commerce, household spending was 5.8% higher in August compared to a year ago.

Nevertheless, economists are bracing for a “quadruple shock” to hit households as soon as this quarter, which could lead to lower economic growth heading into 2024.