A U.S.-China Deal Will Do Nothing To Shrink Our Trade Deficit

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by: Desmond Lachman
Summary

The proposed U.S.-China trade deal, under which China would commit itself to substantially increase its U.S. imports, is very unlikely to make a dent in the overall U.S. trade deficit.

It will not do so since it does nothing to address the underlying causes of that deficit.

Until the Trump administration changes course and addresses the fundamental savings-investment imbalance that is underlying our deteriorating trade performance, we should brace ourselves for ever-increasing U.S. trade deficits in the years ahead.

A singular failure of President Trump's economic policy has been the lack of progress in his stated goal of reducing the overall U.S. trade deficit. Indeed, despite a move to higher import tariffs under the Trump administration, the U.S. trade deficit widened to more than $500 billion through the first 10 months of 2018, its highest level in 10 years.

The proposed U.S.-China trade deal, under which China would commit itself to substantially increase its U.S. imports, is very unlikely to make a dent in the overall U.S. trade deficit. It will not do so since it does nothing to address the underlying causes of that deficit.

A basic arithmetic truth from Macroeconomics 101 is that a country's trade balance is fundamentally the difference between the amount that a country saves and the amount that it invests. If it saves more than it invests, it will have a trade surplus. Conversely, if its savings falls short of its investment level, it will run a trade deficit.

Viewed through the savings and investment lens, it is not difficult to understand why, over the past two years, the U.S. trade deficit has continued to widen despite the U.S.'s move to a very much more restrictive trade policy.

By enacting a very large, unfunded tax cut and by going along with Congress' public spending increases, the Trump administration has substantially reduced the country's public savings level by increasing the budget deficit. At the same time, by introducing welcome regulatory reform, the Trump administration has encouraged higher investment. Little wonder, then, that the U.S. trade deficit has widened as the country's savings level has fallen increasingly short of its investment level.

It is similarly not difficult to understand why the Chinese trade surplus is again rising. As the Chinese government tries to wean its economy from its debt addiction, the economy slows and its investment level declines. When that happens, the degree to which the country's savings level exceed its investment level increases. That, in turn, gives rise to reduced Chinese imports and to a renewed widening in its trade surplus.

Under pressure from the Trump administration, China is now proposing to steadily increase its U.S. imports over the next six years. It is doing so with the purported goal of eliminating the bilateral U.S.-China trade imbalance by 2024.

Even if one were to assume that China were to succeed in that goal, one has to be very doubtful whether this will make a dent in the overall U.S. trade balance. The reason for doubt is that it will have done nothing to change the underlying U.S. savings and investment imbalance that is giving rise to the large U.S. overall trade deficit.

Those arguing otherwise need to ask themselves whether the proposed trade deal will do anything to improve the dismal U.S. budget deficit outlook with expected budget deficits in excess of 5 percent of GDP for as far as the eye can see. They also might ask themselves whether that deal will do anything to slow the pace of U.S. regulatory reform that is currently providing support to a higher U.S. investment level.

Similarly, it is doubtful whether the proposed U.S.-China trade deal will do anything to prevent a rise in China's overall trade surplus. So long as China proceeds to deleverage its economy, one must expect both a slowing in its investment level and a slowing its economic growth rate. That will almost certainly give rise to a lower level in overall Chinese imports and to a rise in the Chinese overall trade surplus.

If China's proposed trade deal were to succeed in eliminating its bilateral trade surplus with the U.S., it would do so at the cost of increasing its trade surplus with the rest of the world.

Sadly, the Trump administration is yet to make the basic connection between the steady rise in the U.S. overall trade deficit and the marked deterioration in the U.S. budget deficit outlook. Instead, even though the U.S. has experienced a twin deficit problem before in the Reagan years, it has persisted in the erroneous belief that a more restrictive trade policy alone would succeed in eliminating the U.S. trade deficit.

Until the Trump administration changes course and addresses the fundamental savings-investment imbalance that is underlying our deteriorating trade performance, we should brace ourselves for ever-increasing U.S. trade deficits in the years ahead.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.