Will big deals address US trade deficit with China?

Let’s just admit it. President Trump did well in Asia. The highlight of his landmark visit to the region has not been impulsive tweets or off-topic rants, but the signing of corporate deals worth around USD$250 billion. Media reports have pointed out that most of the deals are non-binding memorandums of understanding (MOUs) or agreements negotiated much in advance of the event to promote Beijing’s status as a market.

Still, the fact that the deals announced on Thursday (9 Nov) aren’t merely speculative in nature and are, at least, a symbol of the superpowers’ commitment to stable business relations is good news considering the tense atmosphere in the Asia Pacific region with a bellicose North Korea and Chinese territorial ambitions in South China Sea.

The deals include an MOU by China Energy Investment Corp – the world’s largest power company by installed capacity (over 225 gigawatts) and by asset value, and the world’s second-biggest by revenue – to invest USD$83.7 billion in shale gas, power and chemical projects in West Virginia, as well as orders and commitments to do with a Boeing Company sale of 300 jets worth USD$37 billion to China Aviation Supplies Holding.

Yet, if Mr Trump thinks selling more and attracting investment is enough to reduce the US trade deficit with China, which has been steadily increasing on an annual basis, he’s mistaken. He has to take a protean approach that tackles the real causes behind the deficit, key of which is the national savings rate.

What exactly is a trade deficit and what does it look like on a country’s Balance of Payments (BOP)

Before we look at how the national savings rate impacts trade deficit, let’s understand what a trade deficit is.

A trade deficit occurs when a country imports more than it exports. The trade balance forms a big part of the US’s Balance of Payments (BOP). The BOP is a statement that reflects the economic transactions that take place between people in the US and people from other countries, the amount of foreign long-term securities bought by US residents and the amount of US long-term securities bought by foreigners, as well as transfers such as gifts.

The BOP categorizes these transactions into two accounts: The Current Account and the Capital Account.

According to Investopedia: “The current account deals with short-term transactions known as actual transactions, as they have a real impact on income, output and employment levels of a country through the movement of goods and services in the economy”, while, “the capital account mainly includes transactions in financial instruments”.

So a trade deficit in theory implies a current account deficit that is balanced by inflows into the capital account. Because, if you are buying more than you are selling, which leads to a trade deficit (current account deficit) you’d simultaneously have to be attracting foreign investment in US assets and businesses (inflow into capital account; another way of saying borrowing money from foreign investors to fund your spending!).

Now, back to the national savings rate and its interaction with trade deficit.

First let’s examine the relationship between the national savings rate and the trade deficit. Basically, Americans (households and businesses) are spending more than they produce.

Harvard economics professor Martin Feldstein says that the US is investing more of its total output in business equipment and structures than it is saving. This saving and investment decision is what drives the overall trade deficit.

Reducing the deficit “requires Americans to save more and invest less” he says in an article titled: “Inconvenient truths about the US trade deficit”. The US, he explains, has been able to sustain a trade deficit for the past 30 years or so because “foreigners are willing to lend it the money to finance its net purchases, by purchasing US bonds and stocks or investing in US real estate and other businesses”.

Reducing the trade deficit would mean having to make US goods and services more appealing to foreigners and foreign goods and services less appealing to US citizens – and that means lowering export prices and upping import prices, explains Professor Feldstein.

“Thus, eliminating the trade deficit would require shifting about 2.5% of US physical production to the rest of the world, as well as a change in export and import prices that reduces their real value by another 2.7% of GDP,” he adds.

So why is Mr Trump riffing on the dangers of a trade deficit

Basically he believes that US reliance on foreign debt and investment to finance the nation’s spending is a threat to national security. Many economists think otherwise. In an article on the Council of Foreign Relations (CFR) website, former US trade representative Michael Froman says this:

“Every legitimate economist states that measuring trade policy by the size of the goods deficit is probably not a passing grade in a basic economics class.”

Underlying this comment is the belief that a US trade deficit is good for the global economic stability. The CFR article puts it this way:

“The dollar’s role as a global reserve currency and primary tool for global transactions means that many other countries rely on holding dollar reserves, creating massive demand for US financial assets. This means that the US pays little for its foreign borrowing, allowing it to finance its high consumption at low cost, which boosts global demand.”

Despite what economists say, Trump might be accurate in his assessment that trade deficits are harmful to the economy. Barack Obama was of the view that big infusions of foreign capital can lead to financial bubbles like the one that contributed to the US subprime mortgage crisis that started in 2006.

Still, experts like Professor Feldstein caution that getting China, with whom the US has the largest bilateral trade deficit, to buy more American goods is not the way to reduce the trade deficit, which is related to various macroeconomic factors, such as relative growth rates of countries, the value of currencies, and yes, the savings and investments behavior of the US and other countries.

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