President Trump’s economics is flawed, to say the least. The United States runs a trade deficit because of its domestic imbalance between savings and investment: borrowing money from abroad to finance investment at home.
Trump’s politics, though extreme, is a little less unusual. Several former US presidents have lamented the US trade deficit and it has often been a source of tension in the past. While seeking to reduce the US trade deficit by invoking trade restrictions makes no economic sense, there are financial distortions within the United States and elsewhere in the world that make the deficit larger than it would otherwise be. Addressing these distortions might help alleviate these political tensions.
The US trade deficit has been an on-again off-again source of political tension since the 1970s. Under president Obama, for example, then US treasury secretary Timothy Geithner tried to convince G20 finance ministers in 2010 to cap their surpluses or deficits to 4 per cent of GDP. His idea was politely rejected. But the radical proposal showed the political pressure Obama was under to curb the deficit.
President Trump is now taking this to the extreme. Policymakers, business leaders and academics are scrambling to protect the trading system from Trump’s wrath. But those solutions will only be temporary if they fail to address the domestic and global financial distortions making the US trade deficit (and the political ire that it generates) larger than it would otherwise be.
US presidents seem to have ‘selective vision’ when it comes to international economic relations. They watch in horror as money flows out of their economy to purchase goods and services abroad. But they seem blind to the avalanche of money coming into their economy to bankroll their mortgages, finance their investment and pay for their tax cuts.
This flow of finance into the US economy is why it runs a trade deficit. A country that invests more than it is saves, like the United States, imports capital from other countries to finance that investment. This inflow of capital appreciates the US dollar, reducing exports and increasing imports, resulting in a trade deficit.
There is nothing wrong with this arrangement and there is no economic case for changing it. A country might borrow from abroad because it has strong future economic prospects, encouraging its citizens to smooth consumption by borrowing today in anticipation of a prosperous tomorrow. Conversely, a country might lend abroad because it has an ageing population looking for somewhere to invest their savings. The fact that the former will run a trade deficit and the latter a trade surplus enhances economic efficiency by consumption smoothing and matching borrowers and lenders.
But a different conclusion emerges when a trade deficit is being created or worsened by financial distortions, especially when the ensuing trade deficit is inflaming political tensions that are being used to justify trade protectionism and dangerous attacks on the world trading system by a global superpower.
The IMF’s most recent External Assessment Report found that 40 to 50 per cent of the global current account balances were deemed excessive, meaning they could not be explained by countries’ fundamentals and desirable policies. Olivier Blanchard and Gian Maria Milesi-Ferretti have shown how these distortions result in excessive savings in surplus countries and insufficient savings in deficit economies that distort global financial flows and thus trade flows.
The biggest distortion is US fiscal policy and its large unfunded tax cuts and spending promises. My recent modelling at the Brookings Institution shows that for every 1 per cent increase in the US fiscal deficit, the US trade deficit worsens by 0.6 per cent. The consequences of Trump’s tax cuts are available for all to see in December’s US trade figures. Despite all his talk of tariffs and deal-making, the US trade deficit worsened by 12 per cent since his tax measures came into effect.
Foreign leaders may bend to Trump’s will. The laws of economics do not.
Every borrower has a lender. Some of the money made available for US borrowing is also driven by policy distortions. They include US$5 trillion of foreign exchange reserves being accumulated in Asia because of an inadequate global financial safety net, much of which is then invested in safe-haven US assets. They include weak social safety nets fuelling precautionary savings (for example China), low public investment and inadequate macroeconomic frameworks that produce huge surpluses (for example Germany), and weak financial intermediation leading to low investment and a glut of savings in some emerging economies.
There is no automatic economic case for reducing the US trade deficit. But there is an economic case for addressing the distortions that fuel financial imbalances and political tensions. Unless these imbalances are addressed, the US trade deficit will continue to be excessive. And unless 40 years of US political precedent suddenly changes, these deficits will continue to be a source of political concerns, however misguided those concerns may be.
Adam Triggs is Director of Research at the Asian Bureau of Economic Research, the Australian National University, and a non-resident Fellow with the Brookings Institution.