Washington Insider: Wider Trade Deficit Anticipated

The administration’s trade policy is more than ever a very hot topic as the fall elections near. This week, The Hill is running a note by a prominent trade expert, Desmond Lachman – a resident fellow at the American Enterprise Institute – who says the current widening deficits should have been anticipated.Lachman’s experience includes services as a former Deputy Director in the International Monetary Fund's Policy Development and Review Department and as Chief Emerging Market Economic Strategist at Salomon Smith Barney.He says that “not only has the U.S. trade deficit steadily widened... but, it has now reached an all-time high, running at an annual rate of close to a staggering $1 trillion.”Furthermore, Lachman says, given these policies, “There is every prospect that the trade deficit will continue to widen during the remainder of his first term in office.”He also argues that while the widening U.S. trade deficit might have come as a surprise to President Trump and his economic team, “it should have come as no surprise to anyone who had bothered to take an introductory course in international economics.”Such a course, he says, would have taught that the main determinant of trade deficits is not so much the level of a country’s import tariffs but is a question of “whether the country saves enough to finance its investment.”If a country reduces its savings and increases its investment level, its trade deficit will necessarily widen. That has proved once again to have been the case for the U.S. over the past two years. Such courses also teach that the level of the dollar is an important determinant of both exports and imports. A strengthening dollar makes it more difficult to export and cheaper to import, he says.Looking ahead, he “finds every reason to expect that over the next two years, the U.S. trade deficit will rise to well over $1 trillion a year.”“Among the main reasons for expecting this to happen is the Trump administration’s budget policy, which holds out the prospect of a major decline in the country’s savings level," he says.That policy includes an unfunded tax cut which is estimated by the Congressional Budget Office to increase the U.S. public debt by a mind-boggling $1.5 trillion over the next 10 years. It alsoincludes support of a Congress-approved $300 billion increase in public spending over the next two years.As a result of the administration’s expansive budget policy at this late stage in the economic cycle, it is widely expected that over the next two years, the U.S. budget deficit will rise to a peace-time high of over $1 trillion.He also thinks that it is “all too likely” that we will be revisiting the famous twin-deficit problem of the Reagan presidency when we had both an outsized budget deficit and an outsized trade deficit.Yet another reason to fear that the U.S. trade deficit will widen in the year ahead is that a strengthening dollar will discourage exports and incentivize imports. Already, over the past year, the U.S. dollar has appreciated by around 10%. “That strengthening is all too likely to continue in the period ahead as U.S. monetary policy becomes increasingly out of synch with that of our major trade partners," Lachman says.Indeed, at a time that an expansive budget policy is forcing the Federal Reserve to keep raising interest rates to prevent economic overheating, the European Central Bank and the Bank of Japan are keeping their foot on the pedal to provide support to their lackluster economies. In the process, they are increasing the relative attractiveness of U.S. financial assets.Another factor likely to contribute to a further strengthening of the U.S. dollar is the current global financial market turmoil that is being caused in part by the uncertainty engendered by President Trump’s "America First" trade policy.“As has happened so often in the past in times of global turmoil, too much capital is likely to be repatriated to the United States in search of a safe haven for investment,” Lachman thinks. As a matter of arithmetic, under a floating exchange rate regime, as the U.S. capital account surplus strengthens, its external current account and trade account deficits must be expected to widen.Lachman is super-critical of the administration’s economic team. They are all well trained, he says, and should have learned that an unfunded tax cut coupled with public spending increases runs the all-too-real risk of having the country revisit the twin deficit problem of the 1980s.So, we will see. These are not new arguments and the administration seems unlikely to shift main players for economic reasons, but might for political reasons. Now, the President and his team are deeply dug in and believe the results they see are generally positive. Only if that changes or is confronted strongly by the Congress is it likely to shift — a fight producers should watch closely as it proceeds, Washington Insider believes.