Reuters reports that U.S. stocks plummeted after a record trade deficit was announced. But neither report really explains just why a trade deficit is bad. They simply state that there is one, people think it's bad, and Democrats are elated at having more ammunition to use against President Bush.

Of course in an economic sense, there really isn't any problem with a trade deficit. When you buy goods, you give them dollars in exchange for hard assets or services. For instance, when you buy a Toyota you might have a $30,000 trade deficit with the Toyota dealership. But does that really mean you are any worse off? After all, you received a hard asset worth $30,000.

Politicians try to scare people into thinking that sending your money overseas is inherently bad. If that is true, why don't we just outlaw foreign trade? I mean, if we have a periennial deficit, and deficits are really really bad, why don't we just wipe it out by outlawing all foreign goods. That would reduce our deficit to zero. But would we really be better off?

Walter Williams takes a look at what really happens when you buy foreign goods. Dr. Williams rightly points out that the money ends up coming back to us, just in a different form.

A trade balance sheet has two accounts: the current account, consisting of goods and services exchanged, and the capital account, consisting of stocks, bonds and investments. Let's look at it.

Scenario 1: Japan sells us $100 million worth of Hondas. If it bought $100 million worth of rice from us, we'd all agree there would be no trade deficit; the current trade account would be balanced.

Scenario 2: Suppose Japan sold us $100 million worth of Hondas, and instead of buying rice, the $100 million was used to build a factory in Kentucky. We'd have a $100 million deficit on current account offset by a $100 million surplus (buying something) on the capital account - a balance. Instead of creating American jobs by buying rice, jobs would be created by the factory in Kentucky.

Scenario 3: The Japanese sell us $100 million worth of Hondas but neither buy rice nor build a factory but instead deposit $100 million in a U.S. bank. Again, we have $100 million deficit on current account and a $100 million surplus (buying something, in this case a bank account) on the capital account. In this case, the Japanese create jobs by making money available for loans for Americans to buy homes or American firms to build plants or invest in new equipment.

Scenario 4: The Japanese sell us $100 million worth of Hondas (current account deficit). They neither buy rice, nor build a factory, not deposit it in a U.S. bank but buy something already existing like the Rockefeller Center and MGM Studios (capital account surplus). The American who got the $100 million may use it to build a new factory in Kentucky or lend it to people to invest, thereby creating jobs.

Next to the last scenario: Honda sells us $100 million worth of cars (current account deficit) but takes the dollars back to Japan. Dollars cannot be spent in Japan, so what might happen? A British firm may sell the Japanese wool. Instead of being paid in yen, they'd be paid with the $100 million from the Honda sale. The British firm might use those dollars to purchase U.S. Treasury notes (capital account surplus).

Last scenario: This is the one politicians believe, and one I'd actually like. Honda sells us $100 million worth of cars. They buy nothing, and just for the love of dollars, the Japanese keep them stashed in a national cookie jar. Japanese manufacturers work their fannies off just so Americans can be supplied with all sorts of goodies in exchange for slips of paper manufactured by the U.S. mint. That would be wonderful. We Americans could relax and bask in the sun while the Japanese slave to supply cars, cameras and all sorts of high-tech goods in exchange for slips of paper sporting pictures of famous U.S. presidents. Sorry, I'm afraid the Japanese are not that stupid.

What Dr. Williams is saying is that the money always comes back to us. It's our money, so it has to. If it didn't, nobody would accept it. Sure, you can spend American dollars overseas. England will gladly accept American dollars from Japan, but only because it represents an interest in the United States. If the $100 million couldn't be traded for $100 million worth of U.S. goods or services, what would be the point in accepting it?

When it comes to the economy, it seems to me that the only ones that really should be worried or the dolts in the economic forecasting industry.