Trade Deficit Notes

Understanding the Trade Deficit

• The term "trade deficit" commonly refers to:
  • Balance of trade in goods
  • Balance of trade in goods and services
  • Balance on the current account (broadest measure)
• Trade Balance: The difference between a country's exports and imports of goods, services, and some income flows.
  • Applies bilaterally (between two countries) and in aggregate (across all trading partners).
  • Deficit: Occurs when a country imports more than it exports.
• A trade deficit often indicates that a nation:
  • Consumes more than it produces.
  • Doesn't save enough domestically to fund its investment needs.
• The United States has had annual trade deficits for most of the post-WWII period.
• 2019 Data:
  • Global trade deficit in goods and services: 576.9 billion.
  • Trade deficit in goods: 864.3 billion (down from a peak of 837.3 billion in 2006).
  • Services trade surplus: 287.5 billion (U.S. exports more services than it imports).
• Current Account: The broadest measure of a country’s trade balance.
  • Includes trade in goods, services, net income (payments and receipts on foreign investments), and some official government flows.
  • The U.S. has had an annual current account deficit since the mid-1970s.
• 2019 Data:
  • Current account deficit: 480.2 billion, down from a peak of 816.6 billion in 2006.
  • The shrinking deficit was largely due to the 2008 financial crisis, which reduced demand for imports, and the decline of commodity prices.
• Trade Deficit Relative to GDP:
  • U.S. current account deficit reached a high of 5.8% of GDP in 2006.
  • As of 2019, it was 2.4% of GDP.

Causes of the U.S. Trade Deficit

• The U.S. trade deficit reflects that the United States consumes more than it produces and imports more than it exports.
• Most economists attribute the trade deficit to U.S. macroeconomic policies, particularly an imbalance between domestic savings and total investment.
• Primary Cause: Low rate of U.S. domestic savings (by households, firms, and the government) relative to investment needs.
  • To compensate, the U.S. borrows from countries with excess savings (e.g., China).
  • This borrowing allows for higher economic growth than would be possible relying solely on domestic savings.
  • It also boosts U.S. consumption and demand for imports, leading to a trade deficit.
• Role of the Dollar:
  • As a global reserve currency, the U.S. dollar facilitates the trade deficit.
  • Foreign investors seek dollar-denominated assets as safe havens, especially during economic stress.
  • As long as foreigners are willing to lend to the U.S. (e.g., by buying U.S. Treasury securities), the trade deficit can persist.

Impact of Foreign Trade Barriers

• Some policymakers see bilateral trade deficits with countries like China as evidence of "unfair" trade relationships due to market-distorting policies (trade barriers, subsidies, discriminatory regulations).
• While these policies can affect bilateral trade in specific products, they have less impact on the overall U.S. trade deficit.
• Evidence suggests that high tariffs and trade barriers are not correlated with smaller overall trade deficits.
• Reducing protectionist measures in other countries could increase U.S. exports, but if U.S. consumption and savings behavior remain unchanged, the overall trade deficit may not significantly decrease.
• Reduction or imposition of protectionist trade measures in one country might simply result in trade diversion, the shifting of trade from one country to another, and do little to change the overall trade deficit.

Exchange Rates and the Trade Deficit

• Without sufficient capital inflows, a trade deficit can cause adjustments in a country’s exchange rate.
• Net imports lead to a surplus of U.S. dollars abroad.
• If converted to other currencies, the dollar's value tends to decrease relative to those currencies.
• In theory, this should make imports more expensive for Americans and exports cheaper for foreign buyers, reducing the trade deficit.
• However, the dollar's status as a global reserve currency complicates this:
  • The U.S. is a safe haven for storing wealth and an attractive investment destination.
  • When foreigners buy U.S. dollars to invest in U.S. Treasury securities, the dollar appreciates, making U.S. exports more expensive.
  • Foreign governments have intervened in currency markets to prevent their currencies from appreciating relative to the dollar, further affecting global trade balances.

Concerns About the Trade Deficit

• Trade deficits reflect a savings/investment shortfall, requiring the U.S. to borrow from abroad.
• A major concern is debt accumulation from sustained trade deficits.
• The impact depends on how borrowed funds are used:
  • If used for investments in productive capital with high returns (e.g., new technology, equipment), the resulting growth can offset the debt.
  • If used for current consumption (e.g., clothes, household electronics), repayment burdens future generations without increasing their ability to repay.
• Rising U.S. trade deficit could spark a large and sudden fall in the value of the dollar, risking financial turmoil.
  • Foreigners could lose faith in the U.S.'s ability to honor its debt or see the United States as an optimal place to invest in.
• Reducing the trade deficit requires:
  • Boosting domestic savings (reducing consumption and government deficits).
  • Reducing foreign investment (less borrowing from abroad).
  • Realigning exchange rates (depreciating the dollar).

Bilateral Trade Balances

• Bilateral trade balances provide a snapshot of trade relationships with specific countries.
• Influenced by factors beyond trade barriers:
  • Level of economic development.
  • Relative rates of economic growth.
  • Abundance of raw materials.
  • Rates of technological change.
• Bilateral trade deficits can reflect complex supply chains:
  • One country (e.g., China) may be the final assembly point or a supplier of inputs.
  • The added value in that country may be small compared to other parts of the supply chain.