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Trump's Trade Fallacy

Sep 19 , 2017

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Shipping containers wait to be transported at the Georgia Port Authority terminal in Garden City, Georgia. The U.S. deficit in the broadest measure of foreign trade increased at the end of last year to the highest level in three years. March 14, 2012 (Associated Press file)

It seems as if U.S. President Donald Trump is intent on perpetrating a dangerous fallacy: to impose tariffs on American imports to lower the trade deficit. He reportedly told advisors in the Oval Office during a recent meeting in August "I want tariffs." Imposing tariffs, however, is likely to be a futile effort that will do more damage than good. The underlying reasons for America’s persistent trade deficits in goods cannot be remedied with tariffs.

President Trump’s ire seems especially directed at China. Just on August 14, 2017 the U.S. Trade Representative announced an investigation of Chinese infringement of intellectual property under Section 301 of the U.S. Trade Act of 1974. While the illegal copying of American intellectual property rights by Chinese entities is a long-standing trade issue that has merit, the use of Section 301 would allow the Trump administration to impose high and widespread tariffs on Chinese imports. If implemented, such punitive actions could either lead to Chinese retaliation, seriously affecting U.S. businesses, or then be challenged by China at the World Trade Organization, since Section 301 stands outside of its multilateral framework.

These moves are coming despite the fact that the most prominent critic of China’s trade practices in the U.S. administration, Steven Bannon, has left the White House. Why is the Trump administration so enamored by tariffs, a trade policy more commonly employed a hundred years ago?

In Steven Bannon’s words, the Trump administration continues to think that America is at “economic war with China." Certainly, China has made no secret of the fact that it is intent on catching up with developed economies and willing to invest heavily in domestic technology development. If successful, China would, due to its sheer size, become the biggest economy in the world and likely dwarf U.S. global economic influence.

But the United States could still keep up its technological edge by competing head-on with China and developing effective technology and science investment programs. Alas, the Trump administration’s ire seems directed at the large U.S. current account deficit, which was at $469 billion in 2016 and continued at similar levels since Trumps’ inauguration. The administration holds that this is a byproduct of unfair trade practices and “bad” trade deals. Consequently, the administration is not only targeting China, but also South Korea, Germany, other NAFTA members, and just about any country running a trade surplus with the United States.

The case of South Korea is especially illustrative in this respect. A close ally of the United States that is absolutely crucial in any effort to rein in North Korea’s nuclear and missile development programs, it is nonetheless being targeted by an aggressive drive to renegotiate the U.S.-Korea Free Trade Agreement, known as KORUS. Trump has termed this agreement a "horrible deal" that has "destroyed" his country, and he has threatened to terminate it in short order. The culprit, in the administration’s view, is the more than doubling of the U.S. goods deficit with South Korea after KORUS came into effect in 2012 through 2016.

However, upon closer inspection, the doubling of the goods trade deficit with South Korea occurred mainly in two product segments: electronics and autos. Both of these were either not affected by the deal or will only come under its rules in the future.

The fact is that the United States ran trade deficits with over 100 countries in 2016. Something much more fundamental is driving persistent U.S. current account deficits, which have been in place for more than 30 years by now. Simply put, America has a chronic domestic savings deficit. When a country saves less than it needs for investment and consumption, it must import capital (a capital account surplus). The flipside of this relationship is a current account deficit, which, in the case of the United States, is driven by a very large deficit in trading goods.

This deficit certainly has had dire consequences for the production of tradable goods in the United States, especially since the 1980s. The stories of America’s rust belt, replete with scores of abandoned factories, are legend. The social dislocations which industrial hollowing out created in America’s upper Midwest should not be underestimated and drove in part Trump’s presidential win in 2016.

However, the United States is in effect a rather lucky member of the international economic community. Because the U.S. Dollar is the world’s by far most dominant reserve currency, everyone is willing to lend the United States money at low rates, which in turn allows its citizens to keep on consuming and investing far beyond their domestic savings capacity.

Developing countries in particular hoard large stashes of U.S. Dollars to fend off speculative attacks and insure for a rainy day. In a somewhat wicked irony, Wall Street’s speculative activities force poorer developing countries to save too much, driving what former Federal Reserve Chairman Ben Bernanke termed the “global savings glut.” These savings are kept in U.S. Dollars and mostly recycled back into the United States, creating low interest rates that disincentive savings and encourage consumption. And how do other economies get their hands on green backs? By exporting more than they import and thus running trade surpluses with the United States.

If the Trump administration is serious about tackling America’s trade deficit, it should focus on the U.S. dollar and its immense international sway. America’s “exorbitant privilege” – the ability to live beyond its means because foreigners will always be interested in, perhaps even forced to buy its debt at low interest rates – has been very beneficial for American financial and industrial elites, while giving middle and lower classes higher consumption power than would otherwise be the case. Undermining it would have dire consequences for most Americans. Perhaps most ominously, the loss of the “exorbitant privilege” would diminish America’s ability to invest in national defense and thus its geopolitical sway.

The Trump administration’s overall economic nationalism is driving a focus on trade deficits and a seeming willingness to impose tariffs on imports. But this is a major and highly dangerous fallacy. As long as the United States provides the dominant reserve currency, trade deficits are here to stay. Imposing tariffs would be like playing whack-a-mole, clamping down on deficits with one country to only see them rise with another. Only a sustained loss in the value and importance of the U.S. dollar’s global role could over time lead to lower current account deficits. But the costs of such a move would likely far outweigh any gains.

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