Something is going very wrong with the US administration’s effort to reduce the US trade deficit, a principal objective of President Donald Trump’s ‘America first’ programme. Instead of declining according to plan, in the first two years of the Trump presidency, the US trade deficit has been increasing steadily. It now stands at its highest level in the past 10 years and shows every sign of rising.
It has been said of bloodletters of old that when their patients responded poorly to the first round of bloodletting, they simply upped the dosage in the mistaken belief that more bloodletting would do the trick.
Hopefully, the Trump administration will not intensify its import protection policy now that the first round of tariff increases has failed miserably to deliver the desired result. Instead, one must hope that Washington takes a time out from its march towards increased trade protection and tries to determine the real causes of the country’s poor trade performance.
Mainstream economics would suggest there are at least three reasons why the US trade deficit is widening and will continue to do so despite increased import protection.
First, the US trade deficit is arithmetically the difference between what the US economy invests and what it saves. If the country saves less than it invests, it will have a trade deficit, which will rise to the degree that savings fall further short of the country’s investment level.
By engaging in a very large unfunded tax cut and going along with the Congress-approved public spending increases, the Trump administration has eroded the country’s level of public savings. It has done so by putting the country on a path of ever increased budget deficits, which the Congressional Budget Office estimates could exceed $1tn a year for as far as the eye can see. It should be little wonder then that the US trade deficit has kept rising.
Second, the dollar has kept strengthening. It has done so as the administration’s expansive budget policy at this very late stage in the business cycle has forced the Federal Reserve to raise interest rates to contain inflation. That in turn has caused the dollar to rise by about 10% over the past year, which has had the effect of making US exports less competitive and imports cheaper.
Third, the Trump administration’s seeming march towards a world trade war has roiled global financial markets and diminished world economic growth prospects. Global money has sought the safe haven of the dollar and in so doing it has increased the US capital account surplus. Once again purely as a matter of arithmetic, with a floating exchange rate, any increase in the US capital account surplus has to be matched by an increase in the US trade deficit if the country’s external accounts are to balance.
All of this would suggest that if the Trump administration is serious about wanting to reduce the US trade deficit, it needs to mend its ways and not go down the path of increased import tariff protection. A good place to start would be to revisit the country’s inappropriately expansive budget policy, which is sapping the country’s savings and is forcing the dollar ever higher.
However, with economics not being this administration’s strong suit, I am not holding my breath for this to happen.
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.