The currents of trade, President Donald Trump accepts, will ebb and flow. “Sometimes they can be up and sometimes we can be up,” he said in an recent interview with The Economist.
To him, though, a long-term trade deficit—such as that between America and Mexico, which ran to $56 billion in 2016—is bad, bad because it shows that a poor trade deal has been made and bad because money is being thrown away. Achieving more balanced trade, Trump and his team say, along with cutting taxes and encouraging more business investment, will create jobs and boost growth.
Unfortunately the three proposed pillars of this new prosperity are incompatible. When Americans import more than they sell abroad, foreigners accumulate dollars. Rather than sit on that cash, they invest it in dollar-denominated assets. It is as if container ships arrived at American ports to deliver furniture, computers and cars, and departed filled with American stocks and bonds. In time those assets yield returns in the form of interest, dividends and capital gains: For instance, American taxpayers must pay interest to Japanese holders of Treasury bonds.
To the extent that trade deficits thus represent borrowing from abroad, there is some truth to the idea that they could erode American wealth. However, that is to ignore a crucial point about the debt incurred: It comes cheap. America has run current-account deficits, which are substantially driven by the balance of trade, almost every year since 1982. As a result foreigners own American assets worth $8.1 trillion more than the assets Americans own overseas, a difference equivalent to 43% of America’s GDP.
Despite this, America still takes in more income from its investments abroad than it pays out. In 2016 the balance totaled 1% of GDP. This unlikely profit partly results from the “exorbitant privilege” that comes with issuing the dollar, the world’s principal reserve currency. That makes it cheaper for Americans to raise funds.
Viewing the trade deficit as cheap borrowing exposes the tension at the heart of Trumponomics. If they are to do without the foreign capital they currently import, thus closing the trade deficit, Americans must save more. Rather than squirrelling away its money, however, Trump wants the private sector to go on a spending-and-investment spree, spurred on by deficit-financed tax cuts.
“We have to prime the pump,” he said, quite the Keynesian.
It is by no means certain that the primed pump will provide growth on the scale he wants. However, history illustrates the likely effect on the trade deficit. In 1981 President Ronald Reagan’s tax cuts sent the federal government’s deficit soaring, from 2.5% of GDP in 1981 to 4.9% in 1986.
The next decade showed that there was a third factor to consider: companies and households matter, too. As the economy grew rapidly in the late 1990s, the government budget approached balance, yet the current-account deficit grew. This time it was the private sector, giddy with fast growth and a booming stock market, running up debts. In 2000 companies’ net borrowing reached almost 5% of GDP, while households barely saved at all.
Total net borrowing by the government, companies and consumers will determine the current account under Trump. If the administration increases the budget deficit or sparks more private investment—such as the $1-trillion spending on infrastructure that it hopes to unleash—the trade deficit almost certainly will rise.
The 3% economic growth targeted by Secretary of the Treasury Steve Mnuchin would be ambitious under any circumstances. It is particularly so now because it must be achieved as the population ages and as growth in the labor force slows. Between 2014 and 2024 the adult population will grow by nearly 9%, but the ranks of senior citizens will swell by almost 38%.
There is a possible escape from the Trump trilemma. American companies have an estimated $2.5 trillion of cash parked abroad, money that the president wants them to bring home and invest. One 2011 survey found that 54% of this cash was held in foreign currencies. Repatriating it probably would cause the dollar to rise, worsening the trade deficit.
However, if the president removed the underlying incentive to book profits overseas in the first place—America’s high corporate-tax rate—the deficit might appear to improve. Companies no longer would try to make it seem as if production happened abroad through dodges such as moving intellectual property around. With lower taxes in America, accountants might shift “production” back home, improving the trade balance. Economists at Bank of America Merrill Lynch have calculated that this could improve the reported trade deficit by as much as half. Such an improvement, though, would be mainly cosmetic.
© 2017 Economist Newspaper Ltd., London (May 13). All rights reserved. Reprinted with permission.
Image credits: Doug Mills/The New York Times