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A Framework That Provides Clarity

During periods of “low visibility,” confusion reigns: for every indication of one trend, there seems to be a countertrend. The key is to glean from the collective wisdom of reliable leading indicators a clear signal that the economy is headed for a turn.

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Mar 06 2019

The Trump Administration’s Identity Crisis

Regardless of the pending trade deal with China, U.S. fiscal policy has already locked in ballooning U.S. trade deficits for the longer term. This is because of the inexorable logic of the supply and demand of financial capital dictated by the “national saving and investment identity.”



Unlike a theory, which may or may not have empirical support in the real world, an identity is always true. The truism confronting the Trump administration is that the supply of financial capital (from savings within the U.S. and capital inflows from foreign investors that has to equal the trade deficit) must equal the demand for financial capital (private sector investment and the government’s budget deficit).

That’s why the widening of the trade gap despite the administration’s attempts to curb it was entirely predictable last March, when President Trump announced new tariffs on steel and aluminum imports and began moving towards the imposition of tariffs on Chinese imports. Accordingly, in March 2018 we presciently wrote, “Absent a surge in private saving or a plunge in investment, U.S. fiscal policy threatens to lock in a ballooning structural trade deficit, defeating a primary policy objective of the Trump administration.” Today, on the back of a record monthly goods trade deficit of $81.5 billion in December, we have confirmation that the 2018 U.S. goods trade deficit rose to a record high of $891.3 billion. The combined goods and services deficits for 2018 rose to a 10-year high of $621 billion.

Last week, with monthly trade deficits already soaring, President Trump railed against strong dollar policies that encouraged imports and made exports less price-competitive. But while his administration’s aggressive actions undoubtedly induced U.S. trading partners – most importantly China – to engage in serious discussions about broad economic and trade policies that materially disadvantaged the U.S., the upcoming trade deal promising a reduced trade deficit with China is likely to be just as futile as the tariffs in curbing the overall U.S. trade deficit.

The bottom line is that, with trillion-dollar annual federal budget deficits looming, the U.S. goods trade deficit is also likely to be approach a trillion dollars a year in the foreseeable future.

As we explained to our clients a year ago (ICO Essentials, March 2018):

It is possible that some progress will be made in reducing the U.S. trade deficit with China and in curbing Chinese appropriation of U.S. intellectual property. The problem is that U.S. fiscal policy has made it virtually impossible to reduce the overall U.S. trade deficit.
 
Please recall the national saving and investment identity. In principle, the supply of financial capital comes from saving by U.S. individuals and firms, plus the inflow of financial capital from foreign investors that has to equal the trade deficit. This total supply must equal the demand for financial capital, comprised of private sector investment and the government’s budget deficit.

Today, on top of the enormous projected increase in the U.S. budget deficit, most expect a rise in private investment. The resultant surge in the demand for financial capital must necessarily be accommodated by an equal increase in private saving and/or the trade deficit. With a big increase in savings being improbable, the U.S. trade deficit – whether with China or other trading partners – must necessarily balloon. This is the inexorable logic of the supply and demand of financial capital.

[Therefore], no matter what, the U.S. trade deficit is set to increase. [But] if the overall U.S. trade deficit must soar, a reduction in the U.S. trade deficit with China would be infeasible; or else it would be futile, necessitating an increased trade deficit with other economies instead – unless, improbably, private investment is decimated or private savings skyrocket. Thus, those possibilities are either unlikely, or unwelcome, or both.

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