Trade Wars

Donald Trump is angry about the US trade deficit. He blames manufacturing nations like China and Japan for ripping off America, so he is imposing tariffs on Chinese imports into the US to punish them.

Unfortunately, Donald Trump does not understand the economics of international trade, so he is attacking a symptom, rather than dealing with problem.

There are several reasons why the US has been running a trade deficit for many years.

• The United States is a high-income country, (although many Americans are not feeling it.). High-income countries find it hard to compete with manufacturing from low-income countries. Multi-national countries tend to move their production to places in the world where educated labour is cheap. High-income countries have to concentrate on the highly-technical and capital-intensive manufacturing where they have an advantage. The United States has done well in this area, but it needs to do better because many blue-collar workers in the US are still directly competing with cheap labour in Asia.

• Low oil prices and container have made the shipping of manufactured goods from Asia to the United States economic an economic activity.

• The trade balance is only one part of the Balance of Payments, and they all interact with each other. The United States trade balance is the natural corollary to a surplus on the capital account.

• The US dollar is the strongest currency in the world. Since the demise of the Bretton Woods system, many nations in the world hold their international reserves in US dollars. They do this by purchasing US dollar assets, mostly treasury bonds. This inflow of funds has given the US a surplus on its capital account, which has to be balanced by a deficit on its current account. The trade deficit is the direct consequence of the US dollar role as a reserve currency.

  The big benefit of this role is that the US has been able to import cheap manufactured goods without paying for them. The US has been able to engage in numerous overseas wars without paying the full cost. (Wars affect the Balance of Payments in the same way as imports because stuff needs to be purchased overseas. The difference is that they are blown up, rather than carried into the US). Wars and imports have been paid for with bits of paper (mostly US treasury bonds).

  Buying things with bits of paper is good if you can get away with it. Donald Trump does not like the Chinese buying US treasury bonds, however if he wants to stop that practice, the US will have to start paying for all its imports and wars.

• One reason why the US dollar is popular as a reserve currency is that oil is mostly traded in US dollars. Following a spike in oil prices in 1974 the United States persuaded Saudi Arabia to only sell oil for dollars. The U.S. agreed to buy oil from Saudi Arabia and provide the kingdom military aid and equipment. In return, the Saudis would plough billions of their petrodollar revenue back into Treasuries and finance America’s spending. This dollar hegemony worked well for the US, so it has attacked countries like Libya that tried to sell oil for currencies other than the US Dollar. The petrodollar is becoming less important as US dependence on Middle East oil. However, if the US lets it go, the need for US dollar reserves would decline and the trade balance would improve, but US economic hegemony would weaken. I am not sure that this is what Donald Trump wants.

• The United States congress has consistently approved budgets that do not balance for many years. The ongoing budget deficits have to be paid for by issuing treasury bonds. If these were only sold within the United States, interest rates would have to rise significantly. No one wants that, so many of the treasury bonds are sold outside the United States with the Chinese being the main buyer. If the US balanced its budgets, the supply of treasury bonds would shrink dramatically, and the US surplus on its capital account would shrink too. This would have a positive effect on the trade deficit, but no US politician is interested in that solution.

The US trade deficit is mostly the result of decisions made within the US that have produced a surplus on the capital account. Without getting rid of that surplus, the trade deficit is likely to remain, whether or not Donald Trump engages in a trade war.

The Chinese may have manipulated their currency to make sure that they get their share of the US trade deficit. This does not harm the US. They benefit from the cheap televisions and refrigerators. Rather it harms other manufacturing/exporting countries (especially in Asia) that get squeezed out of the US market.