April 27, 2017
Donald Trump gets lots of things wrong, but he doesn’t necessarily get everything wrong. On the link between budget deficits and trade deficits, Trump might be closer to the mark than the NYT.
The NYT rightly took Donald Trump to task for being lost in his trade policy. During his campaign Trump railed against NAFTA and repeatedly complained about China’s currency “manipulation.” Now that he is in the White House it is still not clear exactly what he hopes to do with NAFTA.
In the case of China, he has decided he is now good friends with China’s president Xi Jinping after meeting with him earlier in the month. Trump apparently decided it would be rude to raise the currency issue with his new friend and instead settled for some Chinese trademarks for his daughters’ clothing line.
Trump definitely deserves some criticism for this reversal, but the NYT editorial goes a bit overboard in telling readers that Trump’s tax cut plan will make the trade deficit worse:
“Those tax cuts might increase growth somewhat, but history and many experts tell us it is far more likely that the tax cuts would explode the deficit and drive up interest rates as the federal government is forced to increase borrowing. Investors from around the world would then pour money into Treasury bonds, bidding up the value of the dollar, which would increase the trade deficit — $502 billion last year — as American exports become more expensive in the rest of the world and imports become cheaper. This in turn could cost jobs. Economists say that’s exactly what happened in the 1980s when the Reagan administration and Congress drove up the federal deficit through tax cuts and increased military spending.”
Actually, there is a very weak relationship between the budget deficit, interest rates, and the value of the dollar. While the dollar did rise a great deal in the early 1980s, arguably theis was at least as much due to Paul Volcker’s interst rate policy at the Fed as the budget deficit. The dollar fell sharply in the second half of the decade following the Plaza Accord, in which our major trading partners agreed to try to bring down the value of the dollar. This is in spite of the fact that there was little reduction in the structural deficit over this period.
The biggest run-up in the value of the dollar occurred in the late 1990s, when the budget deficit was turning into a surplus, following the I.M.F.’s bailout of the countries of East Asia, after the 1997 financial crisis. Developing countries in the region and around the world began to accumulate massive amounts of reserves in order to avoid being in the same situation as the countries of East Asia. This accumulation of reserves caused the dollar to rise by more than 30 percent against the currencies of U.S. trading partners.
The trade deficit exploded in response, eventually reaching almost 6 percent of GDP in 2005 and 2006. The budget deficits of the 2000s almost certainly increased employment by creating demand in a context where there was a worldwide saving glut.
Given this history, and the fact that the U.S. economy arguably still has a considerable amount of excess capacity (the employment-to-population ratio for prime-age workers is still down by 2 percentage points from pre-recession levels and 4 percentage points from 2000 levels), it is far from clear that an increase in the budget deficit will lead to a higher dollar and a larger trade deficit.
Note: Typos have been corrected from an earlier version.
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