President Trump is on a mission. He has been reliably informed by economic advisers such as Peter Navarro that putting pressure on countries such as China and Germany to reduce their bilateral trade surpluses with the U.S. will close the U.S.’s large and growing trade deficit with the rest of the world. So he is using trade tariffs as a weapon in a growing “war” with the U.S.’s principal trade partners. “Trade wars are easy to win,” he says.
So far, President Trump has introduced tariffs on goods imports from the EU, Canada, Mexico and China. All of these countries have retaliated with tariffs of their own, and the EU has lodged a dispute at the World Trade Organisation regarding the tariffs on steel and aluminium. President Trump has just announced tariffs on a further $200bn of Chinese imported goods, and has rejected an offer from the EU to cut tariffs on automobile imports to zero if the U.S. does likewise. Battle is most definitely joined, and President Trump clearly thinks he will win. The U.S. trade deficit should be on its way out.
But
instead, the trade deficit is growing. The Commerce Bureau’s Advance Economic Indicators bulletin for July 2018 shows that the deficit in trade in goods has risen to $72.2 bn. Exports have fallen by $2.5bn since June, to $140bn, while imports have risen to $212.2 bn, $1.8bn more than in June. Admittedly, it is early days in the trade war, but this does not look promising. Why is the U.S. trade deficit rising, instead of falling in response to the tariff salvo?
Part of the reason is Federal Reserve interest rate policy. Higher interest rates attract inflows of foreign capital to the U.S. Since the capital account is the inverse of the current account, this necessarily widens the current account deficit, of which the trade deficit is a significant component. Additionally, the U.S. dollar has been on a tear all year, driven up by rising interest rates. This makes American exports more expensive relative to competitors in the rest of the world, and encourages imports. Thus, Fed monetary policy is helping to widen the U.S.’s trade deficit.
But part of the blame for the widening trade deficit also lies at President Trump’s door. The tax cuts have failed to “pay for themselves” and are driving up the U.S. fiscal deficit to its highest level since the Great Recession.
Additional money in the pockets of Americans tends to into consumption spending rather than saving: some of that spending is inevitably on foreign goods. Also, many of the additional bonds the U.S. Treasury is issuing because of the rising deficit are being bought by foreign investors, thus increasing foreign capital flows into the U.S. and therefore - as a matter of arithmetic - widening the current account deficit.
Furthermore, the U.S. economy is thought to be close to full capacity. Wage growth remains subdued, but unemployment is very low and the participation rate is rising. The Congressional Budget Office says that the tax cuts will temporarily increase GDP growth above the U.S. economy’s productive capacity.
If the economy really is close to capacity, then
production won't increase enough to mop up all the additional spending arising from the tax cuts. Spending will therefore go into imports, thus widening the trade deficit. Inflation is likely to rise too, making the prices of foreign goods more attractive than those of U.S.-produced goods; this loss of competitiveness again tends to widen the trade deficit.
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Originally Posted by Aratus
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