The trade deficit widens despite Trump's best, misguided efforts

Something is going very wrong with the Trump administration’s effort to reduce the U.S. trade deficit, which has been a principal objective of its "America First" program.

Indeed, instead of declining according to plan, in the first two years of the Trump presidency, the U.S. trade deficit has been steadily increasing. It now stands at its highest level in the past 10 years and shows every sign of further increasing.

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It has been said of bloodletters of old that when their patients responded poorly to the first round of bloodletting, they simply upped the dosage in the mistaken belief that more bloodletting would do the trick.

Hopefully, the Trump administration will do better than that and not intensify its import protection policy now that the first round of tariff increases has miserably failed to deliver the desired result.

Instead, one must hope that the administration takes a time out from its march toward increased trade protection and tries to determine the real causes of the United States’ continued poor trade performance. 

Mainstream economics would suggest that there are at least three reasons why the U.S. trade deficit is widening and will continue to widen despite increased import protection.

The first is that the U.S. trade deficit is arithmetically the difference between what the U.S. economy invests and what it saves. If the country saves less than it invests, it will have a trade deficit, and that trade deficit will rise to the degree that savings fall further short of the country’s investment level.

By engaging in a very large unfunded tax cut and by going along with the Congress-approved public spending increases, the Trump administration has seriously eroded the country’s level of public savings.

It has done so by putting the country on a path of ever increased budget deficits, which the Congressional Budget Office estimates could exceed $1 trillion a year for as far as the eye can see. It should be little wonder then that the U.S. trade deficit has kept rising.

A second reason why one should not be surprised by the widening in the U.S. trade deficit is that the dollar has kept strengthening. It has done so as the administration’s expansive budget policy at this very late stage in the business cycle has forced the Federal Reserve to raise interest rates to contain inflation. 

That in turn has caused the dollar to rise by around 10 percent over the past year, which has had the effect of making our exports less competitive and our imports cheaper.

Yet a third reason why one should have anticipated a widening rather than a narrowing in the U.S. trade deficit is that the Trump administration’s seeming-march toward a world trade war has had the effect of roiling global financial markets and diminishing world economic growth prospects.

In those circumstances, global money has sought the safe haven of the U.S. dollar, and in so doing, it has increased the U.S. capital account surplus.

Once again purely as a matter of arithmetic, with a floating exchange rate, any increase in the U.S. capital account surplus has to be matched by an increase in the U.S. trade deficit if the U.S. external accounts are to balance.  

All of this would suggest that if the Trump administration were really serious about wanting to reduce the U.S. trade deficit, it needs to mend its ways and not go down the path of increased import tariff protection.

A good place to start would be to revisit the country’s inappropriately expansive budget policy, which is sapping the country’s savings and is forcing the U.S. dollar ever higher. 

However, with economics not being this administration’s strong suit, I am not holding my breath for this to happen.

Desmond Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund's Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.