Trade Deficit with China Widens on Trump’s Watch 

Most things come easier said than done.  Take President Trump’s posture on trade with China. Trump doesn’t want a bigger trade deficit with China.  He wants a smaller trade deficit with China.  In fact, reducing the trade deficit with China is one of Trump’s promises to Make America Great Again.

 

We are often willing to give Donald Trump the benefit of the doubt, despite the fact that his delivery needs a lot of work. Considering his enemies and most vociferous detractors, we reckon he must be doing something right; but we vehemently disagree with his views on trade, some of which are unfortunately becoming policy now. As Murray Rothbard once noted: [P]rotectionist arguments, many plausible at first glance, are really a tissue of egregious fallacies. They betray a complete ignorance of the most basic economic analysis. Indeed, some of the arguments are almost embarrassing replicas of the most ridiculous claims of 17th-century mercantilism: for example, that it is somehow a calamitous problem that the United States has a balance-of-trade deficit, not overall, but merely with one specific country.” At the time Rothbard penned these words, Japan was in the position China finds itself in now; the Japanese stood widely accused of practically bankrupting the US by means of a nefarious scheme that consisted of providing US consumers with cheap high quality consumer goods and investing large amounts of money in the US. The hand-wringing over this was just as ridiculous then as that over China is now. Recently the POTUS imposed punitive tariffs on washing machines and solar panels. The winners: Whirlpool and two bankrupt solar panel manufacturers that aren’t even US-owned companies. The losers: every US consumer and the entire rest of the US solar industry! As noted in this Reuters article: “President Donald Trump on Tuesday signed into law a steep tariff on imported solar panels on Tuesday, a move billed as a way to protect American jobs but which the solar industry said would lead to tens of thousands of layoffs.”  Winning! [PT]

Photo credit: Jonathan Ernst / Reuters

 

In May 2016, he even told a campaign crowd:

 

“We can’t continue to allow China to rape our country and that’s what they’re doing.  It’s the greatest theft in the history of the world.”

 

Yet as Trump approaches the conclusion of his first year in office, he’s achieved the exact opposite of what he said.  The trade deficit with China hasn’t gotten smaller.  It has gotten bigger.  Actually, it has gotten a lot bigger.

For example, the U.S. trade deficit with China from January through November 2017 was approximately $342 billion.  Over this same period in 2016, the trade deficit with China was $317.4 billion.  This amounts to a 7.7 percent widening of the U.S. trade deficit with China that has occurred on Trump’s watch.

 

The deficit in the trade of goods between the US and China. As we often point out in these pages, aggregated economic data as a rule tend to obscure more than they reveal. Data on the trade balance between countries – especially large countries – are standing out in this respect, as they are particularly useless. It may well be that the negative connotations of the term “deficit” make it easy to believe that a trade deficit must be somehow be “bad” – but one has to keep in mind that a trade deficit is merely mirroring an offsetting capital account surplus. Rothbard referred to trade deficits as “a pseudo-problem created by the existence of customs statistics”, which is hitting the nail on the head. He also remarked: “Protectionism is simply a plea that consumers, as well as general prosperity, be hurt so as to confer permanent special privilege upon groups of less-efficient producers, at the expense of more competent firms and of consumers”. We would add to this that instead of interfering with trade and arbitrarily picking winners and losers, the president would do better to focus on the real problem, which is the creation of enormous amounts of money ex nihilo enabled by the central bank-administered fiat money system. [PT]    

 

What gives?  Is China better at manipulating its currency than the U.S.?  Does China somehow outplay the U.S. when it comes to both trade strategy and strategery?

Certainly, The Donald will get to the bottom of it…

 

Unintended Consequences

Earlier this week President Trump called up Chinese President Xi Jinping to have a frank phone conversation on the matter.  From what we gather, Trumpexpressed disappointment that the United States’ trade deficit has continued to grow.

We don’t know what Xi said in response.  But what he could have said was, “Donald, you ain’t seen nothin’ yet!

One of the unintended consequences of increasing the budget deficit to pay for the GOP tax reform bill is that it also increases the trade deficit.  In other words, the budget imbalance between taxes and government expenditures has a direct impact on foreign trade imbalances.  In an article published in Asia & the Pacific Policy Studies, economist Ralph W. Huenemann explains:

 

“In 2016, the American government budgets carried a fiscal deficit of $865 billion, and the balance of payments showed a trade deficit of $521 billion.  A surplus of private savings (including substantial retained corporate profits) of about $344 billion over investment partially offset the budget deficit, but as long as there is such a massive deficit on government budgets, the net inflow of imports will continue.  This is inherent in the nature of national income.  No President, Donald Trump or any other, can change this reality without tackling the government budget deficit.”

 

So if Trump doesn’t want a trade deficit with China then he needs to reduce the government’s budget deficit.  However, reducing the government’s budget deficit is near impossible under the new GOP tax reform bill.  Hence, President Trump is left with a weak hand of bluster.

 

Trump, the US, China, debt and trade – it’s a complicated latticework of relationships.

 

Tax Reform and Trump’s Chinese Trade Deficit Conundrum

This week Reuters released parts of its exclusive interview with President Trump.  On the prospect of a trade war with China, Trump remarked that he hopes a trade war won’t ensue, “But if there is, there is.”

Trump also commented that any change in China’s purchases of U.S. Treasuries would not hurt the U.S. economy.  This is because, according to Trump, “everybody wants to buy Treasuries.”

Let’s hope Trump knows what he’s talking about.  At the moment, China and Japan account for one-third of all foreign-held Treasuries.  However, China has recently tapered back its Treasury holdings to a four month low.  And Japan has reduced its Treasury holdings to a four year low.

But maybe Trump is right.  Maybe China and Japan don’t matter.  Maybe someone else – like the Swiss National Bank – will pick up the slack to finance Trump’s deficit. Still, what would this get him?  It wouldn’t address his trade deficit conundrum; rather, it would make it worse.

The point is attempting to spend a nation to prosperity using borrowed money is not without consequences.  In the short run, an illusion of wealth can be created.  In the long run, the illusion slips into decay and disrepair at the precise moment the bill comes due.

This is one of the tradeoffs of deficit spending based government stimulus that politicians fail to mention when promising free lunches.  Any economic boost that deficit-financed tax reform delivers will be short-lived.

Quite frankly, such a contrived economic boost is akin to burning one’s furniture to stay warm.  The heat it produces feels good while it lasts.  But once the furniture is all burned up, it’s game over.

 

It is worth noting that both today and nearly a century ago some cartoonists were evidently aware of the implications of restricting trade. As an aside, although the US trade deficit with China remains quite high (which is actually a sign that the economy was  recently strong), gross US exports to China have nevertheless reached a new record high as well. [PT]

 

Chart by St. Louis Fed

 

Chart and image captions by PT

 

MN Gordon is President and Founder of Direct Expressions LLC, an independent publishing company. He is the Editorial Director and Publisher of the Economic Prism – an E-Newsletter that tries to bring clarity to the muddy waters of economic policy and discusses interesting investment opportunities.

 

 

 

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9 Responses to “Tax Reform and Trump’s Chinese Trade Deficit Conundrum”

  • Hans:

    Mr Gordon, thank you most kindly for your reply. Despite all I
    have read, I still consider myself to be an economic dolt: so I
    appreciate your input.

    I do believe, Mr Huenemann is not a proponent of MMT but
    rather was raising the Twin Deficit Hypothesis, which he must
    support due to his comment.

    On one hand, Norway’s past eight years, in which it had both
    a trade account surplus and a governmental fiscal surplus would
    seem to support his argument; yet there are too many other examples
    which do not confirm this theory.

    I am in the realm which exceeds my capacity to fully comprehend.

    The complexity of economics has and will remain difficult at best
    to understand, let alone provide accurate, future forecasts.

  • jks:

    If I save a portion of my dollar earnings, that’s a “trade deficit”. Is that bad for the economy? We are told to invest and save because it’s good for the economy. If it’s good for the economy for people in San Francisco and St. Louis to save and invest a portion of their dollar earnings, is it bad for people in Shanghai or Saskatchewan to do the same? Is there something about an arbitrary line drawn on the ground that makes trade a good thing on one side of the line but bad on the other? Is there something about the arbitrary line that makes saving and investing good on one side and bad on the other?

    • Hans:

      JKS, a very good series of questions. To your last two questions,
      I would answer no. My home economic mind thinks, that
      in the end, all economic outputs and inputs reach an equilibrium,
      much like a balance sheet.

      Here is an article from the FR Bank of San Francisco, which is much
      easier to digest than previous links. It suggests, that there are only
      minor and limited nexus in the Twin Deficit Hypothesis. This review
      is more comprehensible for the layman, than the abstract, academic
      links I provided in previous posts.

      https://www.frbsf.org/economic-research/files/el2005-16.pdf (three pages)

  • Hans:

    “Twin Deficit Hypothesis
    Some economists believe that a large budget deficit is correlated to a large current account deficit. This macroeconomic theory is known as the twin deficit hypothesis. The logic behind the theory is that government tax cuts, which reduce revenue and increase the deficit, result in increased consumption as taxpayers spend their new-found money. The increased spending reduces the national savings rate, causing the nation to increase the amount it borrows from abroad.

    Consider that when a nation runs out of money to fund its spending, it often turns to foreign investors as a source of borrowing. At the same time the nation is borrowing from abroad, its citizens are often using borrowed money to purchase imported goods. At times, economic data supports the twin deficit hypothesis. Other times, the data does not. Interest in the theory rises and wanes with the status of a nation’s deficits.”

    https://www.imf.org/external/np/seminars/eng/2010/eui/pdf/BL.pdf

    CONCLUSION:

    ” This paper explores the effect of fiscal consolidation on the current account based on
    a new international dataset of fiscal consolidation and finds strong evidence in favor of the
    twin-deficits hypothesis. Following Romer and Romer (2010), the dataset uses
    contemporaneous policy documents to identify changes in fiscal policy motivated primarily
    by the desire to reduce the budget deficit, and not by a response to short-term developments
    that affect current account dynamics. Based on this dataset, our baseline specification implies
    that a 1 percent of GDP fiscal consolidation reduces the external current account deficit-toGDP
    ratio by about 0.6 percentage points within two years. Thus, reducing the current
    account deficit by 1 percent of GDP would require a fiscal consolidation of about 1.7 percent
    of GDP (1/0.6). We find that a contraction in investment and a real exchange rate
    depreciation play a key role in this adjustment process.”

    Unfortunately, they give no real life examples in this abstract.

    Here is a contradiction of the Twin Deficit Hypothesis, by Professor
    Nazier.

    https://www.researchgate.net/publication/261359212_Empirical_Investigation_of_Twin_Deficits_Hypothesis_in_Egypt_1992-2010

    Another review of this theory.

    https://www.frbsf.org/economic-research/publications/economic-letter/2005/july/understanding-the-twin-deficits-new-approaches-new-results/

    “Conclusions

    Sibling relationships are always complicated, and, as these studies indicate, so is the relationship between the twin deficits. Although standard economic theory predicts that a deterioration in the budget balance results in a deterioration of the current account, the data in Figure 1 show that the two do not always move together. Indeed, the studies cited in this Economic Letter suggest that, if there is any relationship, it is fairly tenuous. The reason is that a number of factors can play a role in determining the impact of budget deficits on the current account. For policymakers, these results ultimately raise questions about the extent to which a reduction in the budget deficit can lead to an improvement in the current account deficit.”

    Michele Cavallo
    Economist

  • Hans:

    The article published in Asia & the Pacific Policy Studies,
    by economist Ralph W. Huenemann, in which I believe he is
    endorsing MMT as a model.

    Someone correct me if I am wong.

    https://marketthoughtsandanalysis.blogspot.com/2011/08/why-deficit-spending-and-creative.html

  • Hans:

    Is (X-M)=(S-I)+(T-G) the much discredited
    Modern Monetary Theory ?

  • Hans:

    “massive deficit on government budgets, the net inflow of imports will continue. ”

    Are you or anyone suggesting, that if the governmental books are balanced
    imports will be at the same level as exports ??

    If so, please give citation(s).

    • M.N. Gordon:

      Thanks for digging into this, Hans. I appreciate the thoughtful discourse. Indeed, the relationship between government debt and deficits and the balance of trade is a complicated matter. And further complicating the matter is the fiat debt based money system and the extreme central bank intervention into credit markets. I’m by no means an expert. But I do find it interesting trying to understand how this all works.

      As I understand it, in a gold standard system, deficits would generally lead to two outcomes: (1) price inflation, or (2) a trade deficit and the export of a nation’s gold to pay for imported goods. However, under a gold standard with free credit markets, where deficit spending is taking place, interest rates would rise to constrain price inflation and/or the trade deficit.

      This is not to say that a balanced budget always results in a balance of trade. A deficit could still occur if imports are paid for via accumulated savings; though eventually the savings would be exhausted.

      Under the dollar reserve system, deficits are financed with debt at a rate of interest that’s artificially suppressed by the Fed’s “open market” operations. This also distorts – suppresses – borrowing costs for businesses and consumers. Presumably, some of this borrowing – though not all of it – flows into purchasing imported goods. Obviously, the percent of deficit spending that goes to a widening trade deficit is dynamic and continually changing over time. The dynamic nature of the relationship makes efforts to calculate it akin to guesswork.

      Lastly, I can’t tell if Ralph W. Huenemann is advocating MMT or not. I’ve generally found MMT to be illogical and indecipherable, including the assertion that taxes do not fund government spending and that the social security problem could be fixed with a $2 trillion coin.

  • TheLege:

    Anecdote time:

    My business buys heavily from China and in recent years wage costs in the southern provinces have sky-rocketed, mainly due to the fact that electronics firms have been hoovering up all available local talent (added to which electronics is where most new graduates want to work). My business mainly deals in wooden furniture and manufacturing of that has now migrated to the north as wage costs (in the south) spiral upwards.

    The days of China exporting deflation are fast coming to an end, IMHO, and I think, despite my US and European contemporaries searching for new opportunities (in places like Myanmar), the ‘Great Moderation’ could suddenly morph into something quite unexpected for markets. Obviously just my opinion but something to keep an eye on in the coming years.

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