The Only Way to Fix the US Trade Deficit

To nobody’s surprise, Donald Trump is a walking contradiction. This is especially true on two of his signature issues: He wants to maximize U.S. domestic economic growth – and, in the interest of “fairness,” do away with U.S. trade deficits.

Mr. Trump boasts about having signed a major tax cut and is putting the United States on a spending spree. What he completely fails to understand is that, precisely because he has chosen to further widen U.S. fiscal deficits for years to come, higher trade deficits for the United States are the inevitable consequence. Hence, two of Trump’s core promises cancel each other out.

Every country’s so-called balance-of-payments – which accounts for all economic activity of that country with the rest of the world – has two major entries. One is the current account, i.e., flows of goods, services and income to and from abroad. The other major entry is the capital account, i.e., flows of lending to and borrowing from abroad.

If a country has a current account deficit, because it imports more than it exports, that deficit must be financed to the dollar by a capital account surplus, so that the overall account is balanced.

In other words, if a country cannot borrow enough abroad to cover its current account deficit, its balance-of-payments will be negative and that means that the country is bleeding its international reserves, which is unsustainable in the long run. This usually has a disciplining effect on consumption.

The U.S. is unique

The crux of the issue for the United States is that it is different in that respect from any other economy in the world. The country basically has no international reserves, because it doesn’t need them. The U.S. dollar is the world’s reserve currency. Therefore, in theory, the U.S. current account deficit will always be covered by the capital account surplus (or through printing more dollars).

The only cost that the United States might incur in running current account deficits is that its interest rates may have to rise to attract capital or the costs of printing money.

As it stands, there are more than enough foreign buyers of U.S. assets to pay for the current account deficit today. Therefore, the United States has economic space for current account deficits unlike any other country in the world.

The U.S. dollar’s reserve currency status

Thus, if Trump is serious about ending the U.S. trade deficit, he would have to see to it that the U.S. dollar loses its reserve currency status. In an indirect way, this is what Trump and his advisors are trying to do by talking down the dollar, accusing China of currency manipulation and describing the euro as grossly undervalued.

In Trump’s own irrational logic of wanting to do away with the trade deficit – this is really the only effective avenue he could pursue to enforce the discipline that applies to all other economies. Unless the U.S. dollar loses its reserve currency status, U.S. consumers (and those include the government) can – and will – always overconsume by buying more goods.

The trouble for Trump is that he could not do so even if he wanted. Reserve currency status is not a sovereign decision by a given country. Rather, it is conveyed by the agreement of all economic actors globally that they prefer to hold assets in that one currency. China’s growth notwithstanding, the renminbi presents no threat to U.S. dollar dominance.

The real crux of the issue is this: If Trump and his trade hardliners were serious about addressing the U.S. current account deficit, they would focus on the underlying cause of that deficit, which is a lack of domestic savings and an excess of private and public-sector spending.

Trump’s love of debt

Alas, we know that President Trump – by temperament and by his professional track record — loves nothing more than creating more debt (or, more tantalizingly, defaulting on such debt).

Under the circumstances in which the United States operates (having the global reserve currency), the only effective way to address the U.S. trade deficit would be to implement a national sales tax.

Heretical as that undoubtedly sounds to Trump’s ears, such a sales tax would cut domestic consumption, while tariffs do not. That is because a sales tax is applied to all goods and services regardless of their origin, not just imports.

As everything, this comes at a price. A consumption tax and greater fiscal prudence will reduce U.S. economic growth, increase unemployment and raise expenses for unemployment benefits by the government, among other things.

That may sound quite unpalatable. But Mr. Trump ought to be clear about one thing: If he really wants to reduce the trade deficit, these are the only measures that will be effective.

If, in contrast, he wants to maximize domestic growth, that – under the circumstances – means a higher trade/current account deficit. There is no middle ground between these options.