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6 years ago

Trade war won't solve America's overall trade deficit

-Reuters file photo
-Reuters file photo

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The United States has the world's largest trade deficit. It has been that way since 1975. The US trade deficit in goods, without services, was $810 billion in 2017. It does better in services trade. Thus, the US trade deficit in goods and services was $566 billion.

The largest US trade deficit is with China, amounting $375 billion, which accounted for more than 65 per cent of the US trade deficit in goods in 2017.The deficit with China expanded dramatically beginning in the early 2000s from an average of $34 billion in the 1990s.

The US also has trade deficits with its both North Atlantic Free Trade Agreement (NAFTA) partners - Canada and Mexico - $18 billion and $71 billion, respectively. Its trade deficit with Japan was $69 billion and with Germany was $65 billion in 2017.

President Trump wants to reduce these deficits with protectionist measures. In March 2018, he announced to impose a 25 per cent tariff on steel imports and a 10 per cent tariff on aluminium. It came a month after he imposed tariffs and quotas on imported solar panels and washing machines. On July 10 the US released a 195-page list of Chinese imports worth $200 billion a year that will attract a 10 per cent tariff, likely to take effect from September. This builds on 25 per cent tariffs on $34 billion worth of Chinese imports into the US that took effect at midnight on July 07.

BILATERAL TRADE DEFICITS: The most common explanation for bilateral trade deficits is cost disadvantage. That is, China, Japan, Mexico, Canada and Germany produce goods that the US needs more efficiently than the US. On the other hand, these countries do not need the goods America is good at making.

However, the US accuses these countries of 'unfair' trade practices, such as currency manipulation, wage suppression, and government subsidies to boost their exports, while blocking US imports. Trump views trade deals such as NAFTA are unfair. He and his advisers argue that renegotiating trade deals, promoting "Buy American" policies, and confronting China over its distorting practices will shrink America's trade deficits.

OVERALL TRADE DEFICIT: The fundamental cause of a trade deficit is an imbalance between a country's savings and investment rates. That is, the US as a whole spends more than it produces, and that additional spending must, by definition, go toward foreign goods and services.

Thus, the availability of cheap money and addiction to debt-financed consumption are the root causes of America's yawning trade deficit. Total household debt in the US rose by $193 billion to an all-time high of $13.15 trillion at year-end 2017, according to the Federal Reserve Bank of New York's Center for Microeconomic Data. It was fifth consecutive year of annual household debt growth with increases in the mortgage, student, auto and credit card categories. The American consumer is loading up on debt which was 202.8 per cent of gross domestic product (GDP) in 2017.

Growing government budget deficit is another factor. The federal budget deficit was $665 billion in FY2017, versus $585 billion in 2016, an increase of $80 billion or 14 per cent. The budget deficit was 3.5 per cent of GDP in 2017, versus 3.2 per cent of GDP in 2016. The US budget deficit will exceed $1.0 trillion by 2020, two years sooner than previously estimated, as President Donald Trump's tax cuts and spending increases do little to boost long-term economic growth, according to the Congressional Budget Office. From 67.7 per cent in 2008 the US government debt rose to 105.40 per cent of GDP in 2017.

These factors are more important than a trade war in determining the overall deficit. Making it harder to trade with specific countries simply shifts the trade deficit to other trading partners. Bilateral deficits reflect particular circumstances of trading relationships with specific countries; but the overall deficit reflects underlying forces in the economy. 

THE US CAN'T HAVE THE CAKE AND EAT IT TOO: There is a reason why the US has a structural trade deficit. This relates to the role of dollar as a de facto 'reserve currency'. That is, the US essentially provides the rest of the world with liquidity and a safe place to store their assets. For example, out of about $10 trillion global reserves in 2016, approximately $6.0 trillion was held in US dollar.

As long as the rest of the world grows faster than the US, the expanding demand for dollars will force America to either create more and more debt-as has been happening-or sell more and more assets. Among the first to identify a trade-off between acting as a reserve currency and running a deficit was Robert Triffin, a Belgian-American economist at Yale. This tension is sometimes called the 'Triffin dilemma'.

Aside from the pride of seeing its currency in use around the world, the US derives economic advantages from running the dominant global reserve currency. First, demand for dollar-denominated assets, like US Treasury bonds, raises their price and hence lowers interest rates. This means that the US pays little for its foreign borrowing, allowing it to finance its high consumption at low cost

Second, while foreign investors buy short-term, low-yielding US assets, Americans can invest abroad in longer-term, higher-yielding assets. The US usually reaps a higher return on those investments than it must pay on its debts. This is sometimes labelled as America's 'exorbitant privilege'.

Third, the US also reaps massive profit - known as seigniorage - from supplying dollar. This arises from the difference between the face value of dollar and its production costs. For example, if to produce a 100 dollar bill costs $5.0 then the seigniorage profit is $95 - a staggering 1,900 per cent!

Therefore, giving up the dollar's global reserve status will have big implications for the standard of living in the US. If the US wants to enjoy exorbitant privilege out of its dollar's role as a major reserve currency then it must run a chronic trade deficit. That is, the US can eliminate its trade deficit or have the world's dominant currency-but not both.

TRUMP'S BELLIGERENT APPROACH WILL HURT THE US: President Trump must know that there is a close relationship between diplomatic/military alliance and reserve currency holdings. Professor Barry Eichengreen of the University of California-Berkeley, a leading scholar of currency policy, notes that countries in military alliances with reserve-currency-issuing countries hold about 30 per cent more of the partner's currency in their foreign-exchange reserves than countries not in an alliance.

If the US retreats from the global diplomatic stage, the country that is most likely to take its place is China which is already edging out the US with its 'Belt and Road Initiative'. Thus, as Trump indiscriminately wages a trade war with US's foe and friends, its foe China will gain an advantage both geopolitically and economically. The emerging global economic shift will not only hurt both the dollar's exchange rate and US borrowing costs, but also its geopolitical interests.

Anis Chowdhury, Adjunct Professor, Western Sydney University and the University of New South Wales (Australia), held senior United Nations positions in New York and Bangkok during 2008-2016.

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