President Trump mistakenly blames the U.S. trade deficit entirely on unfair trading practices by other nations, leading him to threaten counterproductive trade wars, according to the Wall Street Journal. Closer analysis reveals that the low propensity to save among U.S. residents, as well as the high demand worldwide for government and corporate securities issued in the U.S., are bigger drivers of the trade deficit.
Additionally, studies cited by the Journal show that nations with the most protectionist policies, notably those with the highest tariffs, are among those with the highest trade deficits relative to GDP.
The U.S. balance of trade in goods and services showed a deficit of $500.56 billion in 2016, according to the U.S. Census Bureau. This is the largest deficit since 2012, but far below the record $761.72 billion deficit recorded in 2006. Breaking down the 2016 trade deficit, it is the sum of a $749.93 billion deficit in goods and a $249.37 billion surplus in services.
Balance of Payments Accounting
The U.S. consumes more than it produces, generating a deficit in the balance of trade. Meanwhile, the workings of the international balance of payments mechanism mean that a current account deficit in goods and services is balanced by a corresponding surplus in the sum of the capital account and financial account. A persistent current account deficit means that the U.S. is trading capital assets (such as stocks and bonds) for goods and services, thereby borrowing from abroad, as explained by the Federal Reserve Bank of New York.
One way to shrink the trade deficit is to induce Americans to consume less, but this would result in economic contraction, the Journal notes. The other way is to produce more, either to increase exports or to reduce imports. In the case of products no longer manufactured at all in the U.S., recovering lost productive capacity and know-how will be difficult at best. For products that still can be manufactured in the U.S., they will go unsold unless they can be offered at competitive prices. Meanwhile, trying to reduce exports through tariffs runs the risk of retaliation. (For more, see also: Trump May Kill Jobs With Tariffs, NAFTA Exit.)
Capital Flows and Trade Deficits
The flip side of balance of payments accounting is that a country with net capital inflows (i.e., a net surplus in its capital and financial accounts) inevitably will have a corresponding trade deficit. As long as the U.S. remains a highly desirable destination for investment capital, as well as a safe haven for investors worldwide, trade deficits are bound to ensue. To purchase U.S. securities, foreign investors must buy dollars, bidding up their value on the foreign exchange market. A stronger dollar lowers the price of imports to the U.S., while raising the price of U.S. exports, thus increasing the trade deficit.
Effect of Savings Rates
Another balance of payments accounting identity is that savings minus investment equals exports minus imports. For example, in the era when Japan typically ran trade surpluses, it had a very high personal savings rate that exceeded domestic investment, leading to an export of capital. Today, however, the Japanese population is aging and drawing down savings, the Journal observes, and trade deficits are the new normal. It thus was newsworthy when Japan had a current account surplus in 2016 for the first time in six years, the Japan Times reports.
India and Brazil have both high tariffs and large trade deficits relative to GDP because they save less than they invest, while Germany and Switzerland have low tariffs and run surpluses because they have high rates of saving compared to investment, the Journal indicates. In other words, like the U.S., India and Brazil must import large amounts of capital to fund domestic consumption and investment, while Germany and Switzerland fund a greater proportion of spending internally.
High Tariffs Don't Guarantee Trade Surpluses
Studying 125 countries from 2003–14, Joseph Gagnon and Fred Bergsten from the Peterson Institute for International Economics found that those with the highest tariffs actually tended to have the highest trade deficits or the lowest surpluses as well, according to the Journal. Data from the World Bank for the period 2006–15 shows a similar absence of correlation between a country’s level of tariffs and the size of its trade surplus or deficit, also as reported by the Journal.
If U.S. tariffs were raised across the board, ultimately adjustments in exchange rates would neutralize the effect, the Journal observes. Americans would sell fewer dollars to buy foreign currency to fund purchases of foreign goods. The value of the dollar would rise, thereby decreasing the dollar price of imports to Americans and increasing the price of U.S. exports in terms of other currencies. The trade deficit thus would return to roughly where it was before.
Instead, should U.S. tariffs be raised selectively, to target specific countries, bilateral deficits with those countries should decline, while imports from the rest of the world should increase, leaving the total trade deficit largely unchanged, the Journal adds. Targeting Mexico, for example, appears ill-conceived: while Mexico has a trade surplus with the U.S., the Journal points out that it has an overall trade deficit. Mexico thus is absorbing capital from the rest of the world that otherwise might be contributing to the U.S. trade deficit, as described above. (For more, see also: Trump's Illusion: Why Jobs Will Flow to Mexico.)
In their study, Gagnon and Bergsten find that government meddling with exchange rates and the capital markets is a much bigger driver of trade imbalances than explicit trade barriers such as tariffs, the Journal reports. China, for example, is among those countries that have tried to spur exports and discourage imports by intervening in the foreign exchange markets to reduce the value of their own currencies. While Trump has targeted China as a currency manipulator, its recent attempts to bolster the value of the yuan leave him with no current cause for action.
Meanwhile, Taiwan and South Korea (in addition to China) are examples of countries that have depressed the value of their currencies by limiting capital inflows and encouraging their citizens to buy foreign assets rather than invest at home, Brian Setser of the Council on Foreign Relations told the Journal. However, the Journal cautions, Trump's predecessors as president have been unable to deter such behavior, and it is not obvious what he might be able to do instead. (For more, see also: How Trump's Dollar Bashing May Hurt the Economy.)
Trump Stimulus For Trade Deficits
Trump's program of fiscal stimulus is at odds with his desire to reduce the trade deficit, per another report in the Journal. Economists Jeffrey Frankel of Harvard University and Matthew Slaughter of the Tuck School of Business at Dartmouth College told the Journal that fiscal expansion historically has widened the trade deficit. They are former White House economic advisers, to Presidents Bill Clinton and George W. Bush, respectively.
Fiscal stimulus should increase consumption and investment, and thus imports. By expanding the federal deficit, it should increase interest rates, thereby raising the value of the dollar, which will make imports cheaper to Americans and exports more expensive to foreigners. Higher interest rates, in turn, will attract more foreign capital to the U.S., and a larger federal budget deficit will increase the supply of U.S. government bonds. These capital inflows, meanwhile, also will work to increase the trade deficit, as described above. (For more, see also: Why America's Big Creditors Are Selling Treasuries.)