The Strange and Futile World of Trade Wars

U.S. President Donald Trump has a misguided, mercantilist view of international trade. He believes that an external (or “trade”) deficit is a “problem,” and that this deficit is caused by foreigners engaging in unfair trade practices. Accordingly, the president and his followers feel that the U.S. is being—and has long been—victimized by foreigners.

The reality, however, is that the negative external balance in the U.S. is neither a “problem” nor is it attributable to foreigners engaging in nefarious activities. The U.S.’s negative external balance, which the country has registered every year since 1975, is “made in the USA.” External balances are always and everywhere homegrown; they are the reflection and the result of the relationship between domestic savings and domestic investment. And it is the gap between a country’s savings and domestic investment that is the fundamental driver and determinant of its external balance.

Specifically, the current account balance, or “trade deficit,” is the sum of the private savings-investment gap and the public savings-investment gap, or what is known as the “fiscal balance.”  From 1972 until the end of 2018, for example, the cumulative private sector savings-investment gap in the U.S. was a positive $12.8 trillion; that is, U.S. companies and individuals collectively saved—that is, earned and retained—some $12.8 trillion more than they consumed and invested domestically.  But this positive balance was completely overshadowed by the cumulative negative government gap—or cumulative fiscal deficits—of $24.2 trillion during this 47-year period. And thus the U.S. as a whole experienced a savings-investment gap of negative $11.4 trillion that is entirely attributable to the country’s fiscal deficits.

What’s more, the fact that the U.S. recorded a cumulative current account deficit of $11.5 trillion during this period confirms that the U.S. external deficits simply mirror what is happening in the U.S. domestic economy, just as the savings-investment identity suggests. And, of course, the savings-investment identity holds true for all countries, even those with significant external surpluses. Japan and China have both long experienced savings surpluses, and both have run current account surpluses that have mirrored their positive savings-investment gaps.

If the U.S. mercantilists understood what causes trade and current account deficits, they would direct their ire at profligate government spending rather than at foreigners. But they don’t understand. And the leader of the mercantilists, President Trump, is flying blind and presiding over ever-expanding fiscal deficits—which will only ensure that the current account deficits not just continue, but get bigger.