Why Donald Trump should blame the strong US dollar, not China, for its trade deficit
Neal Kimberley says given the role of the strong US dollar owing to its status as the primary reserve currency, tariffs will not help reduce the trade deficit and may backfire
US President Donald Trump doesn’t like the US trade deficit. “We’re like the piggy bank that everyone’s been robbing,” he said last month. His attempts to address the issue, through recourse to tariffs, have raised trade tensions around the world. Yet his strategy might be misguided.
In truth, the centrality of the US dollar to the world financial system, its primary reserve currency status and the reality that commodities are priced in greenbacks, makes the existence of a US trade deficit almost inevitable.
A constant demand for US dollars outside the United States should always help to underpin the currency’s value, and the stronger the greenback is relative to other currencies, the more it makes US imports of overseas goods cheaper in US dollar terms and the less competitive it makes US exports.
Indeed, Cliff Tan, the Hong Kong-based East Asian head of global markets research at MUFG Bank, wrote on June 27 that “no matter what Trump does, he can’t affect the overall US trade deficit”.
Tan applied macroeconomic theory to conclude that “for the US, its government budget deficit … must move 1-for-1 with net exports”, meaning in practical terms that if the US government budget deficit gets bigger, the trade surplus “must get smaller (or the trade deficit get bigger).”
Watch: The US-China trade war and its impact on consumers
That theoretical assertion gets empirical support from a paper, cited by Tan, and published last December by the Peterson Institute for International Economics (PIIE).
PIIE senior fellow Joseph Gagnon’s analysis of data from 111 countries over more than 30 years showed that “fiscal policy and net official flows are the policies that matter for trade balances”.
“Indeed, the relatively large US fiscal deficit in 2017 is a significant contributor to the US trade deficit,” Gagnon concluded. “Increasing the [US] fiscal deficit likely would cause the trade deficit to widen.”
And, of course, given Trump’s enacted tax plan, the US fiscal deficit should widen in the next few years.
Additionally, Gagnon’s analysis found that “trade barriers have very little effect on a country’s trade balance”, which rather undermines the logic behind the Trump administration’s emphasis on tariffs as a way of reining in the US trade deficit.
Of course, geographically targeted US tariffs might mean that the size of a bilateral US trade deficit could shrink but, for all the media emphasis on China-US trade tensions, the Trump administration’s approach is global.
Watch: Christine Lagarde shares her views on Sino-US trade tensions
But focusing on the bilateral China-US trade deficit can still illustrate some potential flaws in the White House’s thinking.
Switzerland’s Pictet Wealth Management wrote last Thursday that given China’s price advantage and specialisation in manufacturing, a lot of what the US imports from China cannot easily be substituted. The US consumer would essentially have no choice but to continue to purchase such goods.
Trump’s trade tariffs could end up proving to be just a new sales tax paid by the US consumer. That would boost US consumer price inflation when data released on Friday is already showing the core personal consumption expenditures price index – the Federal Reserve’s preferred measure of inflation – hit the Fed’s target of 2 per cent year-on-year in May.
On the jobs front, some US manufacturers, which already have a global footprint, have expressed misgivings about Trump’s strategy.
On June 25, mindful of the impact of retaliatory tariffs by the European Union on its motorcycle sales, Harley-Davidson announced it would shift some production overseas, announcing that this “represents the only sustainable option to make its motorcycles accessible to customers in the EU and maintain a viable business in Europe”.
Last week, the Alliance of Automobile Manufacturers, which represents among others companies such as General Motors, Daimler, Ford and Toyota, stated that, if imposed, “tariffs on imported vehicles and vehicle components will ultimately harm US economic security and weaken our national security”.
Meanwhile, General Motors argued on Friday that “increased import tariffs could lead to a smaller GM, a reduced presence at home and abroad for this iconic American company, and risk less – not more – US jobs”.
Indeed a PIIE analysis, captioned “Trump’s proposed auto tariffs would throw US automakers and workers under the bus”, published on May 31, argued that if the Trump administration does opt for tariffs on imported vehicles, it could cost some 195,000 jobs in the US automotive industry, rising to more than 600,000 if other countries were to retaliate in kind.
The adoption of trade tariffs may not achieve Trump’s desired effect and could prove injurious to the US economy. Trump’s tariffs don’t seem to add up.
Neal Kimberley is a commentator on macroeconomics and financial markets