Currency and trade deficit
Currency and trade deficit Trump hates the US trade deficit, and he has made eliminating or reducing large bilateral trade deficits the centerpiece of his trade policies. He thinks that deficits mean the United States is "losing" in global markets because it is buying more goods and services from overseas than it is selling to foreign markets.
This interpretation is misguidedbut there are reasons to be concerned about the aggregate trade deficit. The currency and trade deficit worry is that sustained deficits over an extended period will rack up debt that eventually must be repaid. The United States runs a trade deficit, not because of bad trade currency and trade deficit, but because its citizens spend more than they earn and finance the difference with foreign credit.
Since the deficit is about production and consumption, the tools that will be most effective in reducing it are those that impact how much US citizens, businesses, and governments save. If the administration is serious about reducing the trade deficit, there are ways to currency and trade deficit it. Trade policy, however, is not on the list. Although it seems intuitive that trade policy should be the appropriate instrument for a trade deficit—just as fiscal policy is the right tool for a fiscal deficit—the currency and trade deficit do not work that way.
Higher tariffs on one country or product divert trade to other countries or products, distorting consumption but leaving the trade balance roughly unchanged. Higher tariffs on all countries will reduce imports, but they will also reduce exports, again leaving the trade balance roughly unchanged. The reason is that import tariffs reduce the demand for foreign currency and the dollar strengthens, thus the tariffs reduce both imports and exports and distort consumption and production.
Overall, higher tariffs can be expected to reduce trade and income, but with a negligible impact on the trade deficit. Follow CarolineFreund on Twitter. The reason is that import tariffs reduce the demand for foreign currency and the dollar strengthens. Can you cite any examples where the US took action to reduce its trade deficit and that led to the dollar strengthening?
Otherwise this seems like one of those propositions that exist in theory but not in the real world. Exchange rates are notoriously hard to predict and move currency and trade deficit response to many factors, so it is difficult to find a clean example. In addition, sharp tariff changes are rare and tend to be driven by forces that also affect the exchange rate. One potential example is Chile in the early s.
The currency and trade deficit average tariff fell from 10 percent to less than 5 percent. Theory suggests that increased demand for imports in Chile should have led to greater demand for currency and trade deficit currency and a real exchange rate depreciation. Indeed, the real exchange rate depreciated by 9 percent, and the current account balance actually improved somewhat. There is stronger evidence found in cross-country data. If tariffs lead to few imports without affecting exports, the correlation between tariffs and the trade balance should be positive.
In fact, if anything, the reverse is true: According to the textbook, the Balance of Trade equation of goods and services is defined as Exports minus Imports X-M. And the other question, is related with the third way to reduce the trade deficit: November 6, Three ways to reduce the trade deficit are: Consume less and save more.
If US households or the government reduce consumption businesses save more than they spendimports will drop and less borrowing from abroad will be needed to pay for consumption. This means that consumption taxes—like those that nearly all other countries in the world have—could help reduce the deficit, by discouraging consumption, increasing saving, and reducing the government deficit. In contrast, an unfunded tax cut, such as the one proposed by the administration, will expand the deficit because the government will be consuming more relative to its earnings.
Depreciate the exchange rate. Trade deficit reversals are typically driven by a significant real exchange rate depreciation. A weaker dollar makes imports more expensive and exports cheaper and improves the trade balance. Given the dollar is the world's reserve currency, and still regarded as the safest for investors, it tends to run stronger than other currencies. But when foreign governments actively push the dollar currency and trade deficit to maintain their surpluses, the United States could counteract intervention by selling dollars and buying foreign currencies.
The administration could also encourage the adoption of other major currencies, such as the euro, yen, or renminbi, as alternative reserve currencies. A weaker dollar would be good for the US economy, but relinquishing the role as the dominant currency would reduce the power of the United States in global markets and the seigniorage profit earned.
One of the reasons that the United States runs a trade deficit is because borrowing from abroad is cheap and easy. If it were more expensive, US citizens and the government would borrow currency and trade deficit.
A tax on non—foreign direct investment capital inflows that rises with the size of the inflow could reduce excessive borrowing for consumption and help close the government imbalance. While some worry that capital controls could distort asset prices and reduce investment, they could also curb excessive speculative investment, such as happened before the financial currency and trade deficit.
Jeff Ferry November 9, Hi Caroline, You claim that: Caroline Freund November 9, 3: Gabriel Arrieta December 14, 7: Thank you very much for the consideration, Dr. Leave this field blank. More from Caroline Freund. More on Currency and trade deficit Topic Op-Eds.
Let me begin by thanking Chairwoman Ros-Lehtinen and members of the subcommittee for inviting me to testify on the growing U. No aspect of American trade is talked about more and understood less than the trade deficit.
It has been cited as conclusive proof of unfair trade barriers abroad and currency and trade deficit lack of competitiveness among U. It has been blamed for destroying jobs and dragging down economic growth. None of these charges are true. The most important economic truth to grasp about the U. And those flows are determined by how much the people of a nation save and invest - two variables that are only marginally affected by trade policy.
By definition, the balance of payments always equals zero - that is, what a country buys or gives away in the global market must equal what it sells or receives - because of the exchange nature of trade. People, whether trading across a street or across an ocean, will generally not give up something without receiving something of comparable value in return. The double-entry nature of international bookkeeping means that, for a nation as a whole, the value currency and trade deficit what it gives to the rest of the world will be matched by the value of what it receives.
The balance of payments accounts capture two sides of an equation: The current account side of the ledger covers the flow of goods, services, investment income, and uncompensated transfers such as foreign aid and remittances across borders by private citizens.
Within the current account, the trade balance includes goods and services only, and the merchandise trade balance reflects goods only.
On the other side, the capital account includes the buying and selling of investment assets such as real estate, stocks, bonds, and government securities. The necessary balance between the current account and the capital account implies a direct connection between the trade balance on the one hand currency and trade deficit the savings and investment balance currency and trade deficit the other. That relationship is captured in the simple formula:.
Thus, a nation that saves more than it invests, such as Japan, will export its excess savings in the form of net foreign investment. In other words, it must run a capital account deficit.
The money sent abroad as investment will return to the country as payments for its exports, which will be in excess of what the country imports, creating a corresponding trade surplus. A nation that invests more than it saves - the United States, for example - must import capital from abroad. In other words, it must run a capital account surplus.
The transmission belt that links the capital and current accounts is the exchange rate. As more net investment flows into the United States, demand rises for the dollars needed to buy U. As the dollar grows stronger relative to other currencies, U. Falling exports and rising imports adjust the trade balance until it matches the net inflow of capital. In effect, foreign investors will outbid currency and trade deficit consumers for limited U. Of course, most day-to-day currency transactions are not directly related to trade, but demand for U.
Germany in the early s offers a case study of how this mechanism works. What caused the switch was the huge increase in domestic investment needed to rebuild formerly communist eastern Germany. An increase in currency and trade deficit investment repatriated a huge amount of German savings that had been flowing abroad, thus reducing the amount of German marks in the foreign currency markets and raising their value relative to other currencies.
The causal link between investment flows, exchange rates, and the balance of trade explains why protectionism cannot cure a trade deficit. If Congress were to implement that awful idea, American imports would probably decline as intended. But fewer imports would mean fewer dollars flowing into the international currency markets, raising the value of the dollar relative to other currencies. The stronger dollar would make U.
Exports would fall and imports would rise until the trade balance matched the savings and investment balance. Without a change in aggregate levels of savings and investment, the trade deficit would remain largely unaffected.
All the new tariff barriers would accomplish would be to reduce the volume of both imports and exports, leaving Americans poorer currency and trade deficit depriving them of additional gains from the specialization that accompanies expanding international trade. Government export subsidies would be equally ineffective in reducing the trade deficit.
Partly in response to the Asian financial crisis, President Clinton currency and trade deficit in his federal budget an increase in subsidies to U. By allowing certain exporters to lower their prices on sales abroad, the subsidies would stimulate foreign demand, but the greater demand for dollars needed to buy U. The stronger dollar, in turn, would raise currency and trade deficit effective price of U. Total exports, and hence the trade deficit, would remain currency and trade deficit.
Subsidies only divert exports from less favored to more favored sectors. For example, a higher tariff would presumably raise government revenue through additional customs duties, thus reducing the budget deficit or increasing currency and trade deficit surplus and reducing the need to borrow from abroad - resulting in a smaller trade deficit.
But a tariff can also stimulate investment in the protected industry, increasing demand for foreign capital and leading to a larger trade deficit. After surveying the various theories, Labor Department economist Robert C. Another temptation is to intervene by intentionally devaluing the national currency in the foreign exchange market.
A falling currency and trade deficit can stimulate exports and dampen demand for imports, thus reducing a trade deficit. However, a cheaper currency also means that asset values in that country drop in foreign currency terms, attracting foreign investment flows that increase the capital account and the corresponding current account deficit.
And eventually the weaker currency feeds back into the domestic currency and trade deficit in the form of higher overall prices, that is, inflation. One way to reduce the trade deficit would be for Americans to save more.
A larger pool of national savings would reduce demand for foreign capital; with less foreign capital flowing into the country, the currency and trade deficit between what we buy from abroad and what we sell would currency and trade deficit.
A related way to cut the trade deficit is for the government to borrow currency and trade deficit. The inflow currency and trade deficit foreign capital prompted by the budget deficit allowed Americans to buy even more goods and services than they sold in the international marketplace.
Another, less appealing way to reduce the trade deficit is to reduce investment. That occurs more or less naturally during times of recession, when business confidence falls and companies cut back on expansion plans. As Americans consume and invest less, demand for imports and foreign capital falls along with the trade deficit.
That explains why the smallest U. In fact, the U. That is exactly what happened to Mexico in Perhaps NAFTA critics who believe our bilateral trade deficit with Mexico is such a terrible development would have preferred that the U. Of course, American workers would have suffered, but it would have done wonders for our bilateral trade balance.
An understanding of the all-important role of investment flows should liberate trade policy from its obsessive focus on the current account balance. The trade deficit is not a function of trade policy, and therefore trade policy cannot be a tool for reducing the trade deficit.
Misunderstanding of the U. The following are among the most common and harmful myths surrounding the trade deficit. Countries with which the United States runs large deficits are not characteristically more protectionist toward U. Canada and Mexico, two countries that are very open to U. Americans face a currency and trade deficit external tariff when exporting to members of the European Union, yet some EU members the Netherlands and Belgium are among the top surplus trade partners, and others Germany and Italy are among the top deficit partners.
Trade policy cannot explain those differences. Blaming bilateral deficits exclusively on differences in trade policy once again misses the reality of investment flows. In Japan, high domestic savings rates provide a pool of capital that far exceeds domestic investment opportunities.
That allowed a tsunami of Japanese savings to flow across the Pacific to the United States, where it could draw a more favorable rate of return. Despite the common perception, Japan was actually more open to U.
The same cannot be said for our bilateral deficit with China. Despite substantial progress in the last 10 years, its barriers currency and trade deficit imports remain relatively high. Those barriers partly explain the bilateral surplus China runs with the United States, but the primary explanation is more benign: We like to consume the products China sells. China similarly runs bilateral surpluses with Japan and Europe for this reason. A rising dollar caused by increased demand for U.
If the United States were to impose higher tariffs aimed at imports from China say, by revoking its Normal Trade Relations statusthat too might reduce currency and trade deficit bilateral deficit, but not the overall U. Higher tariffs against Chinese imports would merely shift some of the bilateral trade deficit to other countries while raising prices for American currency and trade deficit.
Since the Cuomo Commission report, the United States has enjoyed seven consecutive years of healthy, noninflationary growth along with historically large and rising trade deficits.
Meanwhile, Japan and Germany, the two export-driven juggernauts that were supposed to eclipse the United States as economic powers in the s, have struggled currency and trade deficit slow growth and rising unemployment. Industrial production in the United States has climbed steadily in the past two decades during a time of historically large U. Between andwhen the U. The same story has repeated itself in the s.
Between and the annual U. Meanwhile, since total industrial production in the United States has surged by 24 percent and manufacturing production by 27 percent. In Japan during the same period, industrial production has grown by only 8 percent, and in Germany growth has been less than 1 percent. America runs substantial bilateral trade deficits with both countries.
Between andU. By any definition, the ability of American industry to compete in the world has not suffered because of a rising trade deficit. The experience of the s and s points in quite the opposite direction. A study by the Institute for Policy Studies in January predicts that the larger trade deficit caused by the East Asian financial meltdown will cost the U.
Columnist Patrick Buchanan, when running unsuccessfully for the Republican presidential nomination incurrency and trade deficit his own, back-of-the-envelope estimate of jobs lost because of the trade gap: The total number of jobs in the United Currency and trade deficit is largely determined by fundamental macroeconomic factors such as labor-supply growth and monetary policy.
Trade with other nations does not reduce the number of jobs, but it does quicken the pace at which production shifts from one sector to another. Trade, like new technology, lowers demand for some jobs while raising currency and trade deficit for others.