Best Way to Address the Trade Deficit—Ignore It

Best Way to Address the Trade Deficit—Ignore It

For each of the past 42 years, America has imported more goods than it has exported. Before 1976, America had a trade surplus each year beginning with the end of World War II.

Imposing tariffs and quotas to create more balance with U.S. trading partners could help reduce imports, but it’s likely to result in a trade war, in which both sides lose. So what’s the best way to deal with the trade deficit?

Ignore it.

While unfair practices, such as China’s ongoing theft of U.S. intellectual property, need to be addressed, overall, a trade deficit has little if any impact on the country’s economic well-being and employment. In fact, when the imbalance is caused by foreign investment in the U.S., as has been the case for many years, the economy benefits.

In spite of the current trade deficit of $566 billion (imports of $2.895 trillion vs. exports of $2.329 trillion), the economy is growing at a rate of close to 3% and the unemployment rate has fallen to 4.1%. The Federal Reserve Board predicts that unemployment will fall to 3.8% this year and 3.6% next year.

“During the Reagan revitalization,” Phil Gramm and Mike Solon wrote in The Wall Street Journal, “strong economic growth was achieved even as the aggregate trade deficit as a percentage of gross domestic product quintupled. During the Clinton boom, the trade deficit more than quadrupled as a percentage of GDP. By contrast, during the weakest postwar recovery, 2009-16, the trade deficit barely changed, and in four of the five recessions between 1980 and 2008, the trade deficit shrank.”

Most economists believe that low saving rates and government deficits significantly contribute to the U.S. trade deficit. And yet the trade deficit quadrupled during the Clinton years, when the U.S. ran budget surpluses and strong economic growth attracted foreign capital.

If anything, the trade deficit has reflected economic health, as in every year the U.S. ran a trade deficit, it also ran a capital surplus.

“The iron law of global trade accounting is that a country’s trade-account deficit must equal its capital-account surplus, and vice versa,” according to Gramm and Solon. “This law follows from the logic of double-entry bookkeeping—and also from the simple truth that when people trade freely with buyers and sellers abroad, the total value of goods, services, assets and currency exchanged by all parties must equal out. Only those who use coercion—governments and criminals—can take more than they give.”

If the supply and demand for dollars were unequal, and trade and capital accounts did not offset each other, the value of the dollar would rise or fall to make them equal.

Thanks to recent tax reform and deregulation, the capital surplus is almost certain to increase.

“The administration’s successful effort to lift regulatory burdens will reinforce earnings repatriation, and foreign capital seems certain to follow,” according to Gramm and Solon. “Thus the net result of the successful tax reform and deregulatory effort will almost certainly be an expansion in the capital surplus—and therefore an increase in the aggregate trade deficit.”

We could reduce the trade deficit by reducing the inflow of foreign capital, but doing so would jeopardize economic growth.

“In the 10 expansions prior to the Obama era, private investment averaged a strong 17.5% of GDP,” according to Gramm and Solon. “During those periods, the federal government competed against private investment for available credit by borrowing, on average, the equivalent of 1.6% of GDP to fund its deficit. Now even if strong growth offsets the forgone revenue from tax reform, the exploding cost of servicing the federal debt, along with bond sales by the Federal Reserve as it normalizes its balance sheet, could easily absorb available credit equal to some 9% of GDP.”

So the trade deficit isn’t the problem. The budget deficit is.

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