U.S. Trade Policy and the Dollar

August 20, 2018

Even as a candidate in 2015-16, President Trump identified reducing the U.S. merchandise trade deficit as a top economic policy goal. There have been several other U.S. administrations in the floating exchange rate era that have taken steps to cut America’s external imbalance, but the Trump administration is taking an approach that hasn’t put the dollar at the center of the effort.

Trump’s focus is on merchandise trade. He largely disregards net sales of U.S. services, net investment income, and net transfer payments, which along with international trade in goods comprises the U.S. current account. The current account, rather than the narrower trade balance, is a component of GDP, and  excessive and rising current account deficits can erode investor confidence in a currency.

In the United States, a chronic surplus in service sector trade offsets about a third of the deficit in merchandise trade. The goods deficit as a percent of nominal GDP has been reasonably stable since 2013, equaling 4.11% that year, followed by 4.19% in 2014, 4.09% in 2015, 4.04% in 2016, 4.08% last year and 4.19% in the first half of 2018. A current account deficit of more than 4.0%, especially if trending upward, might pose a problem to the dollar. But this deficit is stable and well below a three-year average in 2006-8 of about 5.75%.

The U.S. current account deficit equaled just 2.3% of GDP in the first quarter of this year and ranged between 2.2% and 2.6% of GDP from 2013 to 2017. Back in 2006, the year before the start of the subprime credit crisis, the current account deficit had averaged an alarming 5.5% of GDP, and it was at least 4.5% of GDP for five straight years through 2008. The current account gap has been manageable in relative terms for the past several years, and on such a basis it has dropped more significantly than the trade imbalance since the Great Recession.

President Trump is less concerned with the total U.S. trade imbalance than with the largest bilateral imbalances. This is not a totally novel way to look at the matter, but it is conceptually flawed. In the first year of the Clinton Administration, 1993, the incoming administration engaged in a lot of public criticism of Japanese trade practices. It did this even though the U.S. current account deficit that year was a measly 0.8% of GDP.

The U.S. current account deficit will not be significantly affected by the imposition of trade barriers against a few targeted countries. Rather the deficit is determined by the imbalance between domestic investment and savings, and that will depend on relative growth and shifts in the U.S. terms of trade (the ratio between export and import prices). The more expansionary fiscal policy enacted by Congress last December will, other things being equal, lift U.S. demand relative to supply and the size of the trade deficit.

The purpose of the aforementioned Clinton Administration’s complaints about Japanese unfair trade practices was to fan market expectations of yen appreciation against the dollar. Hopefully, the dollar would fall against other currencies, too, lifting the price of imports relative to those of import-competing domestic goods. In a different instance nearly a decade earlier, U.S. policymakers led a G-5 effort to depreciate the dollar and thereby cut the excessive U.S. current account deficit. In less than 3 years to end-1987, the dollar’s value against the yen and Deutsche mark was halved. The Carter administration also spent its first two years trying to weaken the dollar and thereby boost trade and overall growth.

The Trump Administration, unlike these precedents, has not been jaw-boning the dollar downward repeatedly. The favored tool for reducing trade imbalances is instead the threat and imposition of tariffs. This approach shows that the President is less interested in cutting the overall trade deficit than in modifying the geographic distribution of the deficit, which is what at best his approach might accomplish.

The tariff war isn’t weakening the dollar. Most recently it has risen. From the start of May 2016 as Trump emerged as the Republican candidate through the start of 2017, investors bid the dollar up 10% in trade-weighted terms in anticipation of business-friendly policies. Then over the ensuing 13 months as the new administration struggled to pass legislation and became associated with numerous scandals, the dollar unwound that appreciation, falling a bit over 12%. This year, however, there has been a focus upon tariffs, and the dollar climbed 8% to a level that’s only about 4% stronger on a trade-weighted basis than in May 2016. That’s not a particularly meaningful move, and the direction is not consistent with a goal of shrinking the nominal size of the overall deficit or its ratio to the size of GDP.

In this most recent chapter of U.S. frustration with specific bilateral deficits, China is playing the role that Japan did in 1993. The U.S. deficit with China in the first half of 2018 was as big as 46% of the overall U.S. merchandise trade deficit. Even in 1993, the deficit with China represented about a fifth of the total U.S. deficit, but back then the deficit with Japan comprised 51.4% of the total deficit compared to 8.6% of the deficit in the first half of 2018.

Another way to look at the these bilateral trading relationships is to focus on the ratio of U.S. exports to imports. The closer the ratio is to 1.00, the more two-sided is the relationship, but neither the U.S.-Japanese ratio (0.446 in 1993 and 0.507 now) nor the U.S.-Sino export/import ratio (now at 0.256 versus 0.279 in 1993) have changed drastically. They are each quite lop-sided. The export/import ratio with Germany (down from 0.663 in 1993 to 0.471 at present) has moved more sharply. By contrast, the combined export/import ratio from trade with Mexico and Canada has gone from a very even-sided 0.94 when Nafta was launched at the end of 1993 to a still pretty well-balanced 0.86 in the first half of this year.

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




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