International trade negotiations are sure to be in the news in 2014, so we will be hearing a lot about “trade balances.”  But do we know what that term really means, and how the underlying economic realities of a trade imbalance might affect us?

Shining some light on these questions is ExxonMobil’s 2014 Outlook for Energy: A View to 2040.

For the second straight year, our Outlook has offered a special focus on global trade issues. In the 2014 edition, which I recently highlighted here, we sought to explain how trade balances should be viewed in today’s global marketplace, and what all of it means for the U.S. economy.

In a short essay, “Unraveling the meaning of the trade balance,” the Outlook notes that the very idea of trying to achieve “balance of trade” – which reflects the difference in value between a country’s exports and its imports – is a bit of an illusion. Adam Smith himself bluntly wrote in his classic The Wealth of Nations, “Nothing … can be more absurd than this doctrine of the balance of trade.”

Why is that? Because the flow of funds related to a country’s trade and its cross-border investment always offset each other in any given year. This is an iron-clad law of economics that, sadly, is not well understood by a lot of people – including many policymakers.

How do these economic forces work themselves out?  Consider trade between China and the United States.

China invests its surplus dollars earned through trading with the United States right back into this country – in things such as stocks, bonds and physical assets. In this way, our “balance of payments” always evens out, allowing the United States to make national investments beyond our level of national savings. (Further exploring these ideas are former Bear Stearns chief economist David Malpass and the American Enterprise Institute’s Mark Perry. Economist Donald Boudreaux, meanwhile, exposes some of the folly of conventional thinking about trade balances by citing Ikea’s investments in the U.S.)

The cautionary point the Outlook makes is that a country’s ability to save is determined by many factors, including its “fiscal liabilities and general economic development.”

The essay suggests that the best way to think about a trade imbalance is to see it as just one of many signs that jointly depict a nation’s underlying economic realities. Educate well, regulate wisely, and manage a nation’s finances in a responsible way, and a country’s comparative advantages will tend to shine on the world stage. Get those basics wrong, and many national advantages will be held back.

Another point worth noting is that a country cannot effectively use trade barriers to protect itself from competition – though many have tried throughout the centuries. A government can only cut a people off from the benefits of sharing economic strengths with other nations.

This is important to keep in mind as we look to the year ahead. “In the end,” the Outlook concludes, “only nations that promote free trade while also maintaining a sound savings-investment balance, including a solid fiscal foundation, can naturally strengthen their economic well-being and sustain long-term prosperity.”