With all the Trumpian hullabaloo over trade, I want to share with readers a balanced, well-reasoned analysis of US trade issues penned by my good friend Bob Brusca, Chief Economist of FAO Economics. Bob makes it clear that while there are pros and cons to the US’s longtime propensity to run trade deficits, there is one overriding danger in doing so, and there are consequences that are affecting our economy today and will affect it even more seriously in the future.
David R. Kotok
Chairman and Chief Investment Officer
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by Bob Brusca
(Or how our fellow G-7 members learned to whine about trade)
All six of our fellow G-7 members are now complaining about the US and the ‘National Security’ tariffs being imposed by the Trump Administration. I will admit that I do not like this specific strategy. But on the issue of trade confrontation the US’s becoming more aggressive is long overdue. These countries among others have long taken advantage of the US and are provided in general much better access to the US market than US firms are provided access to their markets. In the case of Canada, trade is governed by the NAFTA agreement, for better or worse.
Los Seis Caballeros: The US is an unfair trader?
First let’s look at the complainants: In this corner stands the group consisting of Canada, Germany, France, Italy, the UK and Japan. The US stands alone.
These countries (summed) have tended to run $200 billion worth of surpluses (US deficits) annually over the past decade on their bilateral accounts with the US (ten-year average is $196.5b, made smaller by the US import contraction in the Great Recession).
Why does this matter?
International economists (full disclosure: I am one) will tell you that having a bilateral deficit does not matter. They will go on to say that whether a country has a surplus or a deficit does not matter. This latter point is ‘evolutional.’ Old economics texts refer to running a current account deficit as ‘living beyond your means.’ That is hardly a statement of ‘neutrality.’ But the real point is this: WHY are so many countries running a surplus vs. the US and why are US deficits so intractable? In the case of the US, where GDP is 70% made of consumption, it is to take advantage of cheap consumer goods made abroad, NOT to invest. As a result the US more easily can finance its fiscal deficits and keep interest rates low. It can carry a higher debt load, and citizens benefit from cheaper goods today as future generations are saddled with the debt whose accumulation permits this state of affairs. Milton Friedman is reported to have said, if someone is willing to sell to you below cost you should buy as much of it as you can. Well, we have been doing that; and living for the short run has consequences. There is still a question of damage and distortion. The damage and distortion include the fact that in this instance there is intergenerational unfairness. We do the excessive consuming while future generations do the excessive paying.
The real point is that our deficits do matter and are bad because they represent consumption not investment. If the US were investing for its future these capital inflows that finance the deficit would finance themselves. But when we only use them to pay off and sustain high fiscal debt or corporate debt and to fuel consumption, then the deficits are bad.
Deficits being good or bad should not be a function of the currency regime. Under the gold standard countries WOULD NOT run deficits because they would have to pay for them in gold. Now that we only pay with fiat money IOUs, economists are no longer so concerned about whether it’s a deficit or a surplus on current account – but that is wrong. The gold standard was too restrictive, but that does not make the anything-goes floating currency regime right regardless of the outcome. Countries still need to mind their balance of payments and to run deficits for the right reason... and duration.
It should be lost on no one that the most fiscally sound countries do not run strings of current account deficits. They run surpluses.
Under a fluctuating exchange rate system, exchange rates are supposed to move to put current accounts back in equilibrium – has this happened?
The Kvetching Six
We do not even have to look at exchange rates to answer this question. Only the UK metrics are close to a balanced position with surpluses sometimes and deficits other times. Everyone else runs only surpluses (US deficits) all the time on their bilateral accounts.
My position on this [issue] is that this is proof that WTO has got it wrong and these countries are foreign exchange manipulators that do not allow their currencies to RISE (undercutting their competitiveness and increasing their purchasing power). As a result they stay too competitive. The US remains uncompetitive. And US demand serves to stimulate growth in these countries. And, yes, the US gets more and cheaper goods as a result. It also gets higher unemployment (or less labor force participation), lower wages, lower inflation, lower interest rates, and is encouraged to carry more debt financed by foreign capital inflows (the counterpart of current account surpluses).
Of course, I do not even have on this chart some of the Asian countries that maintain an economic agenda of export-led growth.
Under FREE TRADE each country is supposed to produce according to its comparative advantage. But the US is producing less; Asia is producing more; and the US is consuming more as the structural US current account gap leaches US income off and stimulates growth overseas while taking away from growth in the US. US spending stimulates growth abroad as US citizens buy imports (foreigners’ exports) and their exporters thrive on these payments. This is NOT FREE TRADE.
It is also true that the US has fewer commercial policy (tariffs quotas and other restrictions) impediments for foreign goods, making the US an easy export target compared to other countries where US goods DO NOT face the same level playing field.
Trump’s ‘National Security’ tariffs do not remedy any of this, but they do put the rest of the world on notice that the US is finally going to stick up for its firms and that US commercial policy may be used even when the problem is not a specific foreign commercial policy.
You see, it is impossible to force a nation to appreciate its currency. But if it keeps its currency too low and keeps an unfair advantage from that, what recourse is there? Foreigners blame the US. We consume too much and save too little. But it’s the natural thing to do when faced with the choices they give us. Foreigners buy a lot of US-based financial investments, which keeps their own currencies weak. Capital flows into the dollar strengthen the dollar and weaken the currency they come from. In this way foreign holdings of US Treasury securities in particular (allegedly made to beef up needed foreign exchange reserves) are instruments of long-term currency manipulation.
Looking at the G7 (putting the US back into this group), the chart above shows current account positions as a percentage of GDP by country. From early 1996 through 2008 the US ran the largest deficits relative to GDP. Since then Canada and the UK have surpassed the US. France has run deficits from 2008 (no data before then). Italy is back to running surpluses; so is Japan in the wake of its natural disasters, when it unexpectedly needed to import oil when it had to shut down its nuclear reactors. Germany has a surplus at 8% of GDP and may still be growing it larger.
So how is the US a trade pariah with this record?
The specifics of the Trump action are poorly chosen. The national security ruse is thin gruel, but it is legal and accessible. The US has much stronger grounds to pressure even our closest allies to shape up and be fair.
To be really fair we can step up and shoulder our share of the blame. US economists for years were in denial about the damage that global unfair trade was doing to the economy. They called it ‘fair trade’ or said it was close enough to it. Well, it is not close enough to it. The US balance of payments currently is being repaired by oil and fracking. We should not let the illusion of a smaller trade and current account deficit, because of our selling our natural resources, mask the fact that US firms are not as competitive as they need to be AT THESE EXCHANGE RATES.
There is no foolproof way to get other countries to revalue their currencies. Forcing current-account-surplus countries to make changes is nearly impossible. But Trump’s actual use of commercial policy to go after imbalances caused by other issues may have merit. Trade needs to be fair. Americans have enough ‘stuff.’ We don’t need more cheap stuff; we need jobs. And while there are gobs and gobs of jobs, there are not enough good ones. A weaker dollar would help that. But of course one aspect of Trump’s policy is that the dollar has actually been rising. And this is in part because the Federal Reserve has a program of steadily raising rates.
I hope this discussion puts the trade issues in perspective. One big problem is that no one really can observe and identify an equilibrium exchange rate. Also that an exchange rate is necessarily a bilateral thing – it takes two to tango. And it is often hard to get agreement on what it should be. But over long periods of time we can look back and see what misaligned currency rates have done. The trail of US current account deficits is such a thing. Viewing it as a problem unfortunately gets us caught up in a crossfire in which some push for a strong dollar for political or geopolitical reasons or just for what they think are patriotic issues. And if you are the greatest, best, most productive economy on earth, you will have the strongest currency, and it would not kill you. But if you are no longer that dominant economically and if you still push for such a strong dollar, bad results will follow… as we have seen. So the US situation has been the result of US misunderstandings about the facts regarding its international competitiveness and foreign opportunism. But US deficits are leaching wealth from the US. We are living off of our ‘former greatness.’ Our labor market lacks skills. The dollar can’t be the strongest currency in the world unless our capital is the newest and the best, operated by the brightest. And now the only way we get there is with H1B visas. That is not the answer.
We have many needs as a country. And you can’t start by boasting. You can trash talk before the game, but if you don’t bring it during the game, in the end you will be embarrassed. That is what is happening to the US in the wake of all this strong-dollar talk. We should aspire to a strong dollar someday. But not today. You can’t impose that on an economy that is not ready for it without some very adverse results.
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