National Interest

by Desmond Lachman

    The US economy has long been shielded from the unsustainability of its trade and budget deficits. It may not be for much longer.

    So much for President Donald Trump’s promise that his import tariff policy would eliminate the country’s gaping trade deficit. Yesterday, the Census Bureau and the Bureau of Economic Analysis reported that November’s goods and services trade deficit almost doubled from the previous month to $56 billion.

    More tellingly, those agencies reported that, far from declining, the trade deficit increased by about 4 percent in the first eleven months of the year to $840 billion. This widening occurred despite Trump’s hike in import tariffs to their highest level in 100 years. It also occurred despite last year’s approximately 10 percent depreciation of the dollar, which should have boosted exports and restrained import growth.

    The key point Trump struggles to grasp is that the trade deficit simply reflects the fact that the country spends more on consumption and investment than it produces. Or, equivalently, as Keynes taught us, a trade deficit is the result of a country saving at a rate that falls short of the rate at which it invests. As long as the country does not save enough to cover its investment, it will be running a trade deficit. And this will be true no matter how high an import tariff wall that we might erect.

    Viewed through this lens, it is not difficult to understand why the country is running such large trade deficits. After all, we are now running budget deficits of $1.7 trillion per year, equivalent to 5.5 percent of GDP. If we insist on running massive budget deficits that depress the country’s savings level, we must expect a large trade deficit. This is especially true when we simultaneously use budget policy to stimulate investment.

    Trump’s One Big Beautiful Bill Act makes it all too likely that the trade deficit will continue to remain at least at today’s high level because of a gaping budget deficit. According to the Congressional Budget Office, Trump’s budget initiative is likely to add $3.4 trillion to the deficit over the next decade. According to the International Monetary Fund, the United States is likely to run a budget deficit of between 6 and 7 percent of GDP for the foreseeable future. That is bound to keep our savings level at a rate that will not nearly match our investment level, especially at a time when we are experiencing an Artificial Intelligence-led investment boom.

    As bad as our twin budget and trade deficit is today, it could get considerably worse if Trump gets his way on several spending proposals he is now floating, and if the Supreme Court rules that Trump exceeded his authority in hiking import tariffs on national security grounds. Not only is Trump proposing a $2000 “dividend” check from import tariff revenues. He is also proposing to increase defense spending by $500 billion over the next two years. He is making those proposals at a time when our budget deficit is already at a worrying level.

    All of this does not bode well for the US dollar and the inflation outlook. A key point the Trump administration willfully ignores is that we are highly dependent on foreigners to finance our twin budget and trade deficits. Indeed, foreigners already hold $8.5 trillion in US treasury bonds, or about 30 percent of all outstanding treasuries.

    This makes it difficult to understand why Trump seems to be going out of his way to denigrate our trade partners, to subject them to punishingly high import tariffs, and to undermine their confidence in our reliability as a debtor by attacking the Federal Reserve’s independence. That is bound to make them increasingly reluctant to finance our profligate spending ways.

    Troubling signs are now coming from the markets that we could be heading for a dollar and bond market crisis. Over the past year, the dollar has lost 10 percent in value, even as high import tariffs and a favorable short-term interest rate differential should have boosted it. Over the same period, the gold price has approximately doubled to over $5,000 an ounce, while long-term US treasury bond yields have risen despite a 175-basis-point cut in the Federal Reserve’s interest rate.

    Trump would do well to heed the warning signals of real trouble ahead coming from the dollar, gold, and bond markets. Maybe then he would take early steps to address our twin budget and trade deficit problem. However, judging from his remarks this week that he welcomes a weak dollar, I am not expecting an economic policy U-turn anytime soon.