Mr. Trump's Cognitive Dissonance About The Trade Deficit

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One of Donald Trump's more important economic policy objectives is to reduce the size of the country's trade deficit. Yet the macro-economic policies that he is proposing for the country would seem to be at sharp odds with that objective. By proposing a budget policy that would lower national savings and that all too likely would cause the US dollar to appreciate further, Mr. Trump would be creating the very conditions for a widening rather than a narrowing in the US trade deficit.

In framing budget policy, Mr. Trump seems to be overlooking a matter of basic economic arithmetic. Arithmetically a country's external balance is the difference between the amount that it saves and the amount that it invests. If a country saves more than it invests, it will run an external surplus. Conversely, if it saves less than it invests, it will run an external deficit.

Seemingly oblivious to this basic point of economic arithmetic, Mr. Trump is proposing far-reaching cuts in both corporate and household tax rates. At the same time, he is proposing large increases in both public infrastructure and defense spending. He is doing this in the hope that these policies will cause the US economy to accelerate somehow from its present 2% growth rate to around 3-4%, which would generate additional tax revenue collections.

Should a significant pickup in economic growth not materialize, the net effect of these policies will almost certainly lead to a significant widening of the US budget deficit and to a corresponding decline in US public savings. That in turn would lead to a widening of the trade deficit since it is highly improbable that the decline in public saving would be offset by either a corresponding increase in private savings or by a decline in overall investment.

A further basic weakness of Mr. Trump's budget proposal is that it would involve a significant fiscal stimulus to the US economy at the very time that the economy is at or very close to full employment. If carried through, such a policy is bound to require the Federal Reserve to raise interest rates meaningfully in order to contain inflation. That in turn is more than likely to attract capital to the United States in search of higher interest rate returns that would exert further upward pressure on the US dollar.

An appreciation of the US dollar is the last thing that the country needs if it is to reduce its trade deficit. Since an appreciation is very much the equivalent of the United States cutting tariffs across the board on its imports and of imposing taxes across the board on its exports. Incentivizing imports and dis-incentivizing exports would hardly seem to be the way to reduce the country's trade deficit.

A real concern is that, as the US external deficit widens on account of Mr. Trump's reckless budget policy approach, he will double down on his interventionist approach to trade matters. As underlined by his recent intervention with the Carrier Corporation, this seems to be his preferred way of dealing with trade issues. If he continues to go down that path, he will risk leading the global economy down the road to the beggar-thy-neighbor and tit-for-tat trade retaliation policies of the 1930s, which hardly had a salutary effect for either the US or the global economies.