Twin deficit danger of ‘America First’

Trump unaware of influence of low US savings

Economic policy consistency is not the Trump administration’s long suit. All one need do is look at how the administration’s China trade proposals conflict with its budget policy. That conflict is not likely to end well for the US and global economies.

A principal objective of President Trump’s ‘America First’ trade policy is to eliminate the US trade deficit in general and that with China in particular. To that end, President Trump has announced a large increase in steel and aluminium import tariffs as well as higher tariffs on $60bn of Chinese products. In addition, he is demanding that China takes measures to reduce its bilateral trade deficit with the US by $100bn.

While implementing his America First trade policy, President Trump is also pursuing an expansionary budget policy. He is doing so even though the Federal Reserve judges that the US economy is at or beyond full employment. He has introduced an unfunded tax cut that will increase the budget deficit by $1.5tn over the next decade, according to the Congressional Budget Office, and he has gone along with a Congressional bill that will increase public spending by $300bn over the next two years.

The Trump administration seems unaware that a necessary condition for the reduction of the US trade deficit is that the US must raise its savings rate relative to its investment rate. This holds true whatever the government might do regarding import restrictions and exchange rate policy. Overlooking this basic tenet of economics seems to blind the administration to the fundamental inconsistency between its trade policy objectives and its budget proposals.

According to the Committee for a Responsible Federal Budget, a Washington-based non-profit organisation, the tax and spending measures will increase the US budget deficit to more than $1.1tn as early as 2019, from $660bn in 2017. At a time when household saving has sunk to very low levels, the prospective widening in the budget deficit will almost inevitably reduce the overall level of savings. It will also cause the trade deficit to widen as it did in the time of the Reagan twin deficits, when the US experienced both a fiscal and a current account deficit.

A clear and present danger to the US and global economic outlook is that a widening of the US trade deficit would heighten the chances that the world will drift towards a destructive trade war. It would do so by raising the prospect that a misguided President Trump would double down on import restrictions as a response to further widening in the trade deficit.

Another area in which the administration’s China trade policy conflicts with its budget policy relates to the financing of the US budget deficit. One has to question the wisdom of picking a fight with China, the largest holder of US Treasuries, at a time when the US budget deficit is set to approximately double over the next two years.

With global asset prices having reached lofty levels, the last thing the Trump administration needs is a spike in long-term government bond rates that could roil US and global financial markets. Yet that is what the US seems to be inviting. Rather than being a large buyer of US Treasuries, the Federal Reserve has become a seller in an effort to shrink its bloated balance sheet. And the US is antagonising the largest holder of Treasuries while government borrowing is set to rise sharply.

Given the stakes involved, one has to hope that President Trump will find a way to back down from his unilateral America First stance. Judging by his past rhetoric and the recent changes in his economic team, I am not holding my breath.

Desmond Lachman is a Resident Fellow at the American Enterprise Institute. He was formerly a Deputy Director in the International Monetary Fund’s Policy Development and Review Department and the Chief Emerging Market Economic Strategist at Salomon Smith Barney.

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