U.S. Current Account and The Dollar

October 9, 2018

Reducing the U.S. trade deficit is a centerpiece of President Trump’s economic policy agenda, but the imbalance has been widening in 2018. A $570.5 billion census-basis merchandise trade deficit in January – August was $50.4 billion, or almost 10%, larger than the year-earlier deficit. Bilateral deficits grew each by $21.4 billion with Europe and China. That with other countries in the Western Hemisphere went up $12.1 billion, and the deficit generated by trade with OPEC increased $4.7 billion.

The U.S. current account deficit, which includes traded services and investment income flows, has remained comparatively stable and manageable, nonetheless. It wasn’t always so. As a percent of GDP, the current account was 3.0% or higher for nine consecutive calendar years ending when the Great Recession hit in 2008. In the last five of those years, the deficit-to-GDP ratio was 4.5% in 2004, 5.2% in 2005, 5.5% in 2006, and 4.7% in both 2007 and 2008. The shortfall plunged to 2.7% of GDP in 2009 and in only one subsequent year, 2011, got as high as 3.0%. The ratio ranged between 2.2% and 2.6% since 2013 and fell from 2.4% in the first quarter of this year to just 2.0% in the second quarter.

President Trump’s concern about trade primarily disregards the non-goods components of the current account, however. Success will be measured by a decline in the net deficit from U.S. exports and imports of goods, both in the aggregate of all commerce with other countries as well as in the individual deficits with each of America’s trading partners.

The favored policy tool for shrinking the U.S. trade deficit, import tariffs, is not well-suited for the task. For one thing, such tariffs are a tax that mostly hits U.S. consumers rather than foreign producers. For another, tariffs invite retaliation. An infamous chart of U.S. monthly exports plus imports from 1929 to 1933 resembles a spider web, as trade flows spiraled progressively inward. The U.S. economy was not so much affected then by changes in the trade balance as by the steep implosion of both imports and exports that together exerted a huge drag on gross domestic product.

A significant and sustained decline of the U.S. trade deficit can be best achieved in one of two ways: either U.S. demand needs to slow relative to demand elsewhere, or one needs to noticeably increase the cost of imports and export-competing goods relative to the cost of exports and import-competing goods. The huge U.S. tax cut bill approved and signed into law in December 2017 is designed to achieve the opposite result of the first condition, and that’s already happening. In contrast to a 1.9% annualized increase in U.S. real GDP from mid-2009 when the Great Recession ended through the second quarter of 2017, the growth rate over the ensuing four quarters was 2.9%, and GDP grew 4.2% at an annualized rate between the first and second quarters of this year. The wider merchandise trade deficit that has emerged this year reflects faster U.S. relative economic growth.

The imposition of import tariffs by the United States would promote the second means for shrinking the deficit if it didn’t evoke retaliatory trade barriers by other countries. But it invariably does elicit such a response. That’s also happening already.

A different way to make traded prices more advantageous for the United States would occur if the dollar somehow depreciated a lot. That’s occurred sometimes. A comparison of monthly averages of the dollar’s trade-weighted value against major currencies whose values are allowed to be set by market forces shows a 37.6% dollar depreciation from February 1985 to January 1988. In time, that move sufficiently modified trading incentives sufficiently to achieve a tiny current account surplus by 1991 equal to 0.3% of GDP.

More recently, movements in the trade-weighted dollar have neither been sweeping enough nor always appropriate from a directional standpoint to promote a big decline in the trade deficit. The dollar’s trade-weighted slide from the first quarter of 2017 through the first quarter of 2018 was less than 9%, and half that drop has been reversed subsequently.

The recipe for shrinking the U.S. trade imbalance has about as much chance of succeeding as did the twin middle eastern wars fought against Afghanistan and in Iraq. A lack of tangible progress may encourage repeated escalated waves of  protectionist measures. It makes one wonder if the goal is really about reducing the trade deficit or just making America a more insular economy.

Copyright 2018, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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