Why the U.S. Trade Deficit Keeps Growing

(Bloomberg Opinion) -- Ever since U.S. President Donald Trump came to power, his administration has focused on shrinking the trade deficit, pressuring foreign countries to reduce barriers to American exports. Yet the government recently reported that the deficit rose significantly in 2018, to $621 billion.

What gives? Shouldn’t Trump’s efforts in China and elsewhere have some effect on trade with those countries, and hence on the overall U.S. trade imbalance? Unfortunately, that’s not how it works.

The U.S. trade balance depends primarily on how much the country as a whole spends, earns, saves and invests. Americans collectively spend more than their income, which means that the country’s savings do not cover its investment needs. To make up the difference, the country must borrow from abroad – that is, foreigners need to increase their holdings of dollar-denominated assets. These capital inflows are the flip side of the trade imbalance. 

Put another way, savings imbalances lead to trade deficits. If you think about it like this, you’ll see that last year’s increase in the deficit was preordained at the end of 2017, when Trump signed the Tax Cuts and Jobs Act into law. Together with higher caps on federal discretionary spending, the legislation sharply increased the government budget deficit. This widened the gap between domestic saving and investment, requiring even greater foreign capital inflows – and a bigger trade deficit – to maintain balance.

But wait a minute. If trade barriers are coming down faster abroad than in the U.S., shouldn’t this help?  At the margin, perhaps: U.S. exports might go up in the relevant countries. But the growing federal budget deficit has a greater effect. All else equal, the fiscal stimulus pushes up U.S. interest rates, which makes U.S. assets more attractive to foreigners and causes the dollar to appreciate. The stronger dollar, in turn, reduces the competitiveness of U.S exports abroad and increases the competitiveness of foreign imports in the U.S. The result is a larger trade deficit. The same story played out in the 1980s, when the Reagan tax cuts boosted the dollar and the trade deficit increased sharply.

Can’t the U.S. just raise tariffs to keep imports out? Again, this might work for particular goods and services, but in the aggregate it will just lead to a stronger dollar, lower exports and a shift to a different set of imports. Worse, foreign countries might retaliate with their own tariffs, further reducing U.S. exports. And ultimately, the bottom line doesn’t change: The trade balance will depend on how these changes affect the balance between domestic saving and investment.

Let’s be clear: Seeking lower trade barriers is a good idea. The less barriers there are, the more the U.S. can concentrate on exporting goods and services where it has a competitive advantage. Removing obstacles to trade can lead to greater specialization and economies of scale around the world, boosting productivity and living standards. That said, it can also hurt particular industries and regions in the short term, which is why it’s so important to provide assistance to the people affected. Without such help, the political support for lower trade barriers can erode over time, much to the detriment of the world’s long term well-being.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Bill Dudley is a senior research scholar at Princeton University’s Center for Economic Policy Studies. He served as president of the Federal Reserve Bank of New York from 2009 to 2018, and as vice chairman of the Federal Open Market Committee. He was previously chief U.S. economist at Goldman Sachs.

©2019 Bloomberg L.P.