As President Donald Trump met with his Cabinet on Thursday for a pep talk for the trade war, the Federal Reserve quietly released some news that casts doubt on Trump’s strategy for erasing America’s $570 billion trade deficit.
Trump seems to believe that the deficit is the result of other countries taking advantage of the U.S. by dumping their underpriced goods on us. All the U.S. needs to do to reduce the trade deficit down to zero (he says) is to rewrite the trade rules. It’s just a matter of leveling the playing field so that the United States sells just as much (or more) to China, Mexico, Canada and Europe as they sell to us.
There’s no doubt that Trump has a point: Unfair trade has crippled some U.S. industries and killed a lot of jobs. Something must be done.
Trump’s simplistic answer ignores a structural imbalance in the U.S. economy that practically guarantees a large trade deficit year after year. I’m talking about the chronic lack of savings in the United States, which forces us to either cut back our investments in the future or else borrow hundreds of billions of dollars from foreigners.
The Fed released its quarterly report on the financial accounts of the U.S. on Thursday, reporting that net national savings — the sum of savings by households, businesses and government — dropped to $370 billion in 2017, or 1.9% of gross domestic product, less than a third of the post-war average. Since the Great Depression of the 1930s, the only time national savings have been lower was during the severe downturn from 2007 to 2011.
And national savings might get worse. We know government savings will fall sharply over the next few years as the tax cuts and spending increases take hold. Private savings will increase somewhat, but probably not dollar-for-dollar.
Why is savings important? Because any funds used for investment (I’m using the word “investment” in the economic sense, not the market one) must by definition come out of savings — either ours or those of foreigners. In 2017, the U.S. had a huge financing gap — the difference between net savings and net investment — of $427 billion, or 2.2% of GDP.
How do we fill that gap? By borrowing the excess savings of foreigners. In other words, we borrow back the dollars that foreigners earn on their exports to the United States in order to fund our investment in productive assets.
It’s important to remember that this identity linking the trade deficit with low national savings is simply an accounting identity, not causation. Low national savings doesn’t cause the trade deficit directly.
The crucial transmission link between savings, investment and trade is the exchange value of the dollar which reflects the global demand for dollars from both U.S. residents and foreigners. Conceptually, the dollar’s value adjusts to the revealed global preferences for savings, investment and consumption of domestic and imported goods and services.
The Trump administration has been talking down the dollar on mercantilist grounds. A weaker dollar would make U.S. goods and services relatively cheaper than foreign ones, thus working to lower the trade deficit. But getting a weak dollar to persist isn’t easy. It looks as if the Fed may raise interest rates at a quicker pace than previously expected. Higher rates would offset some or all of the dollar weakening.
The missing piece of the puzzle is the demand for investment. Boosting U.S. investment in factories and infrastructure is the goal of a lot of Trump’s policies. Getting U.S. businesses to invest more in productive capacity would be a big win for the economy, because investment and productivity have been so weak. More investment would boost productivity, create more jobs, and increase wages and probably profits as well.
However, businesses don’t invest to be patriotic; they do it to make money. So far, businesses are hopeful, but cautious about capital spending.
The billion-dollar question is whether Trump’s policies — fiscal stimulus and protectionist measures — can boost U.S. incomes and savings enough to reduce the 2.2% financing gap and allow the trade deficit to shrink. The answer probably depends on how our trading partners react to Trump’s trade gambit, either by coming to a quick agreement on new, more U.S.-friendly trade rules, or on a tit-for-tat escalation in tariffs that would leave everyone worse off.