There were no witches in Salem, Massachusetts, in 1692 and 1693, yet dozens of people were executed based on a false understanding of the world. Today, a similar misconception is shaping US economic policy: US President Donald Trump’s “reciprocal” tariffs reflect the mistaken belief that the US suffers from large trade deficits, and these reflect economic decline and foreign exploitation. Fueled by bad accounting, this narrative now threatens to undermine both US prosperity and the international order that sustains it.
By traditional accounting standards, the US ran a cumulative current-account deficit of US$14.4 trillion from 2000 to last year. At first glance, this suggests a country living beyond its means. Had that deficit been financed through borrowing at an average interest rate of 4 percent, net interest payments should have risen by US$576 billion. However, over that same period, net financial income declined by only US$19 billion.
So, where is the missing US$557 billion? A closer look reveals that the gap reflects an often-overlooked US strength: the ability to generate value through ideas, technological innovation and expertise. These intangible assets underpin a global network of subsidiaries and consistently deliver returns high enough to offset the current-account deficit.
While the US ran a merchandise trade deficit of US$1.2 trillion last year, it also recorded a US$295 billion surplus in cross-border services. More importantly, US subsidiaries abroad generated US$2.1 trillion in sales, compared with US$1.5 trillion by foreign subsidiaries operating in the US. The result was a net services surplus of US$895 billion, almost enough to offset the goods deficit.
Foreign subsidiaries of US companies also generated US$632 billion in net income last year alone. Assuming a conservative 4 percent return, that implies an asset base of US$15.8 trillion — an astonishing figure for a country that, on paper, ran a cumulative current-account deficit of US$14.4 trillion.
To make sense of this apparent contradiction, consider a different narrative: The US effectively borrowed not US$14.4 trillion, but US$28 trillion. Half went toward domestic spending; the other half was used to fund foreign direct investment.
The key distinction lies in how US companies deployed these funds. By combining capital with intangible assets such as ideas, intellectual property and organizational capabilities, they generated returns of 8 percent, far above the 4 percent typically earned by passive investors, including foreign lenders.
In essence, the US exports not just dollars but a form of invisible capital that serves as a reliable source of income. In 2005, my colleague Federico Sturzenegger and I used the term “dark matter” to describe the unmeasured value embedded in knowledge-based assets that traditional accounting fails to capture.
These structural dynamics have long allowed the US to run persistent trade deficits without suffering the usual consequences, such as rising interest payments. Since the end of World War II — and, more explicitly, since the 1994 Uruguay Round of trade negotiations — the US has led efforts to institutionalize protections for cross-border investment and intellectual property. In return, developing countries gained expanded access to the US’ capital and consumer markets. Though imperfect, the global trade system has enabled the US to extract lasting value from its intangible capital.
That foundation of US power is now in jeopardy. Trump’s “liberation day” tariffs are not just a symbolic gesture; they signal a willingness to abandon the very principles that have underpinned global trade and investment for decades. If the US is seen as retreating from its commitment to open markets, other countries might respond by scaling back intellectual-property protections. The earnings of major US firms — particularly in tech, pharmaceuticals and entertainment — could face higher taxes, stricter regulations, and even expropriation. As a result, the income that helps offset the US’ current-account deficit could dry up.
Of course, the damage from Trump’s agenda might extend far beyond trade. The strength of the US’ economic model has always rested on its openness to people, capital and ideas. For decades, the US has been a magnet for talent in science and technology, from the European emigres who helped build the atomic bomb to today’s artificial intelligence researchers and biotech entrepreneurs.
However, as the US turns inward — attacking universities, undermining research and closing itself to the world — it is destroying the knowledge base that generates the “dark matter” sustaining its external balance.
The geopolitical consequences could be profound. US allies such as Canada and the EU are already hedging against the Trump administration’s unpredictability by strengthening ties to each other and with China, and Latin American countries are following suit. China, for its part, is working to reduce its reliance on the US market, and universities around the world are trying to attract US-based academics and researchers. If the US is no longer viewed as a reliable guarantor of the rules-based international order, it risks drifting into strategic isolation.
History offers valuable lessons about the dangers of Trump’s approach. In the early 20th century, German Kaiser Wilhelm II dismantled the complex alliance system carefully constructed by former German chancellor Otto von Bismarck. Dismissing Bismarck’s system as outdated, Wilhelm pursued an assertive unilateral policy that ultimately led to his country’s encirclement and set the stage for World War I. He failed to see that what appeared to be constraints were, in fact, the foundation of Germany’s security and influence.
Trump is making a similar mistake. Viewing the system of trade and investment as a trap rather than a triumph, he is determined to dismantle the mechanisms that have enabled the US to prosper, extend its influence and avoid great-power conflict for about a century.
There is nothing inevitable about the decline of US power, but misunderstanding the causes of the US trade deficit — and trying to fix what is not broken — risks turning a statistical illusion into a very real crisis.
Ricardo Hausmann, a former Venezuelan minister of planning and former chief economist at the Inter-American Development Bank, is a professor at Harvard Kennedy School and director of the Harvard Growth Lab.
Copyright: Project Syndicate
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