When Deputy U.S. Trade Representative Dennis Shea tore into the European Union last week, attacking the $178 billion goods trade deficit the United States runs with the EU and acknowledging that the deficit “colors” every aspect of America’s approach to trade with Europe, it was hardly a departure for anyone in the administration.
U.S. President Donald Trump has, since 30 years before day one in office, been obsessed with trade balances, viewing the difference between a country’s imports and exports as something like the balance sheet of a business—more outflows than inflows must be the road to bankruptcy (something Trump is intimately familiar with), so the only path to solvency must be to balance the books by importing less and exporting more.
During Trump’s first two years in office, that metric—his own—got worse, with the U.S. trade deficit steadily widening. Last year, it shrank a bit to $616 billion—a bit better than in 2018 but still a wider gap than when he took office.
But the fact is, the myopia around the trade balance has in fact colored every aspect of the administration’s approach with every single major trading partner: the trade war with China, the browbeating of Japan and South Korea, the renegotiation of the North American Free Trade Agreement, the vilification of India and Vietnam, and, of course, the repeated broadsides about Europe’s “unfair” trade due to the size of that bloc’s trade surplus, especially Germany’s role in the surplus.
Just what do Trump and his administration get so wrong about trade deficits, and why does that mistaken diagnosis hamper so badly America’s efforts not just to deepen strategic ties with allies but to make any progress on trade at all?
Trump and his trade officials argue that the trade balance is a good indicator of whether America is able to trade fairly or if it’s getting “ripped off.” That sounds like common sense.
The overall trade balance, whether a deficit (like the United States) or a surplus (like Germany), isn’t a very good indicator of overall economic health, for starters. In recent years, there has been an almost inverse relationship between domestic growth rates and unemployment and the size of the trade deficit: It ballooned during the go-go years of the first George W. Bush administration, and when the U.S. trade deficit did shrink dramatically between 2008 and 2010, that was because of the sudden and catastrophic damage of the financial crisis.
More to the point, a trade balance—oddly enough—doesn’t say very much about the health of a country’s trading relationships. That’s because the trade balance is simply part of a broader accounting measure known as the current account balance, and that is actually determined by a country’s domestic savings rate and investment habits—not by trade barriers to U.S. trucks, nuts, and beef or by a U.S. penchant for French wines and German cars.
“Foreign import barriers and exports subsidies are not the reason for the US trade deficit,” Martin Feldstein, the former chief economic advisor to Ronald Reagan, explained in 2017. “The real reason is that Americans are spending more than they produce.”
If a country, like the United States, spends more money than all the households, businesses, and government can cobble together, the difference has to come from overseas. The current account balance is simply the reckoning of all the goods, services, and money that flow in and out of any given country in any given year. “In other words, saving minus investment equals exports minus imports—a fundamental accounting identity that is true for every country in every year,” Feldstein wrote.
That has been particularly evident as Trump keeps signing off on huge annual budget deficits, now approaching $1 trillion, which must be financed with money from abroad. That doesn’t by itself mean that the U.S. trade deficit is a sign that the United States is getting ripped off by its trading partners, nor would an overall trade surplus be a sign that the economy is a powerhouse.
“The trade/current account deficit tells you nothing about an economy’s strength, weakness, or purchasing power,” Barry Eichengreen, a professor of economics at the University of California, Berkeley, told Foreign Policy.
But Trump seems to think that countries with a trade surplus, like Japan most of the time or Germany, are savvier traders or somehow taking advantage of other countries. Why can’t the United States just copy them?
As long as the United States spends more than it makes and continues to run up huge deficits and more debt, it would be very hard-pressed to run a trade surplus. But the issue for the United States is even more central: It could copy Germany’s model only if it wants to give up the primacy of the U.S. dollar and complete dominance of the international financial system—the very primacy that lets the Trump administration slap sanctions on whomever it likes, forcing even close allies like Europe to jettison their own foreign-policy priorities.
Any normal country—one whose money is not the global reserve currency—that ran budget deficits decade after decade would eventually face a comeuppance. That fiscal profligacy would lead to higher interest rates and a weaker currency over time. And that, in turn, would mean fewer imports and more exports—tending to balance out the trade deficit naturally.
But the dollar is the global reserve currency, and U.S. debt is the global safe investment; that means there is a virtually unlimited appetite for U.S. dollars and U.S. debt, no matter how out of whack the budget seems from year to year. That means the self-correcting mechanism of higher interest rates, a weaker currency, and a more balanced trade picture never gets going.
In exchange for those seemingly permanent trade deficits, the United States gets to play financial policeman all around the world, using the central role of the dollar and the U.S. financial system to advance its own agenda in almost everything, from trade with Venezuela and North Korea to Europe’s dealings with Iran.
OK, but Trump rails about the trade deficit with specific countries, like China or Mexico. And Shea was talking about the goods trade deficit with Europe—surely a bilateral trade deficit is a clear indicator that a given trade relationship is out of whack?
Bilateral trade deficits are an even more worthless metric to judge the health of a trade relationship. Or as Eichengreen put it: “A particular bilateral trade deficit or surplus is totally devoid of economic meaning.”
First, they’re not very accurate. With supply chains for businesses now snaking all over the world and back and forth across borders, it is very difficult to say with accuracy what value of what goods came from which country; take the famous example of the iPhone. On paper, each smartphone counts as an import worth hundreds of dollars from China, but in reality China provides only a few dollars’ worth of value, with the rest coming from U.S. inventions and other Asian suppliers. Yet in the trade ledger, it all counts as a U.S. import from China.
More broadly, any given bilateral trade balance—such as the $178 billion goods deficit with Europe that so riles U.S officials—is simply a slice of the overall trade balance, which is determined by savings and investment. Forcing open any given market to allow for more exports of U.S. agricultural products, or raising tariffs to cut down imports from any given country, could make some difference for any one bilateral trade balance. But, like squeezing a balloon or playing whack-a-mole, the underlying problem will just crop up elsewhere.
Take the United States. In 2019, it reduced the bilateral goods deficit with China to $346 billion from $419 billion the year before, a seeming victory for Trump’s blend of tariffs and coerced exports. (And he has hopes that the “phase one” deal signed last month will mean even more U.S. exports to shave that deficit further, though the outbreak of the coronavirus makes that unlikely.)
But an uptick with one country did almost nothing to solve the underlying problem. The U.S. goods deficit with nearly every other trading partner—Europe, Mexico, Canada, Switzerland, South Korea, Malaysia, Japan, Taiwan, and India—increased to make up nearly all the difference.
But Trump did manage to shrink his own growing trade deficit last year. Maybe the combination of tariffs and forcing more market access overseas is paying off?
No. The trade deficit shrank by about 1.5 percent not because of a boom in U.S. exports but because Americans bought even fewer imported goods.
More to the point, Trump’s policies are almost the worst imaginable if the goal, which few economists actually share, is to shrink the trade deficit. He has run massive budget deficits, which by definition skew the current account balance toward the negative. And huge tax cuts, which helped drive the huge deficits, also prompted a couple of years of sugar-high economic growth—another factor that tends to boost imports and widen the trade deficit, especially when there’s little spare productive slack in the domestic economy to provide more goods to buy and consume. Finally, his use of tariffs on imports, all else being equal, tends to push up the value of the U.S. dollar, making imports relatively cheaper and exports relatively more expensive—again, widening the trade deficit.
If the idea were actually, for some reason, to shrink the trade deficit, the remedy would be pretty much the opposite: much smaller deficits, fewer or no tariffs (which would alleviate one cause of a rising dollar), and slower growth that would mean less consumer spending on coveted foreign goods. But that’s hardly a recipe for election-year success.