Trade Deficits and Tariffs

 I apologize in advance for beating a dead horse, but I wanted to spout off about trade deficits and tariffs before they departed from the news cycle and went to issue heaven. The first part of this blog will deal with trade deficits incurred by the United States and if they are relevant to the functioning of our economy. After that, we will look at tariffs and whether or not they are an effective tool in addressing a nation's trade deficits. Lastly, I will tender the most expeditious and efficient cure in terms of reducing America's chronic annual trade deficits.

The United States has run a trade deficit for 50 years, since the 1970s. In other words, for half a century, the U.S. has imported more goods and services than it has exported. The trade deficit was at a small level in the 1970s, a modest level in the 1980s, and then expanded significantly over the past three decades to the point where it now exceeds $1 trillion per annum. By far our largest bilateral trade imbalance is with China. The American economy has fundamentally changed over the past 50 years. In 1970, manufacturing jobs represented 26% of employment in the U.S. These days, the percentage of manufacturing jobs has dipped below 10%. This evolution has effectively lowered wages for non-college-educated workers and has cost the U.S. somewhere between three and four million jobs. As witnessed by the emergence of Trump and his MAGA acolytes, these import-related job losses are driving a populist backlash to trade and globalization that causes political and social volatility.

There are many economists and trade experts who do not believe trade deficits hurt the economy. I embrace the position that trade deficits are neither all good, or all bad, but rather consist of trade-offs (no pun intended). The primary negatives, depressed wages and job losses for certain segments of the work force, have already been mentioned. The U.S. economy on an overall basis has benefited from lower-priced foreign goods. Consumers have realized significant savings. To remain competitive, American companies have had to increase productivity and efficiency. It also needs to be pointed out that technological innovations have played a much larger role in deindustrialization than trade trends. Look for this to continue. The robots are coming. Lastly, the exchange rate of the dollar is extremely relevant. A stronger dollar makes foreign products cheaper for American consumers while making U.S. exports more expensive for foreign buyers.

One can make the argument that on a net basis the United States has benefitted from the post-World War II monetary system agreed upon a Bretton Woods near the end of the aforesaid war. The dollar, backed by gold at the time, was formally considered the world's reserve currency. The dollar as the global reserve currency means other countries rely on holding dollar reserves, creating massive demand for U.S. financial assets. This means that the U.S. pays little for its foreign borrowing, allowing it to finance its high consumption at low cost. The singular role of the U.S. economy in providing liquidity to the global economy and driving demand around the world makes a U.S. trade deficit central to global economic stability. In exchange for foreign creditors owning about one-third of our outstanding national debt, Americans have received imported goods at a reasonable cost. This has contributed to keeping a lid on inflation.

Imposition of tariffs is seen by some as a remedy to cure trade deficits. Our current president has referred to "tariff" as the most beautiful word in the English language. He has also referred to himself as "Tariff Man." On April 2nd Trump announced wide-ranging, punitive tariffs on the entire world, friends and foes alike, even on remote islands only occupied by penguins. It was declared "Liberation Day," when in fact it should have been called "Obliteration Day." Trump's reciprocal tariff calculations were absolute, unadulterated nonsense. The White House did not properly measure tariffs imposed by various countries. Instead, it drew its estimates from bilateral trade deficits in goods. As a traditional conservative with a predisposition to look at tariffs with a negative eye, I consider tariffs nothing more than an unnecessary tax that can distort incentives in the economy. This can lead to inefficient resource allocation. History tells us that protectionist policies to close trade deficits invariably fail. Instead of promoting jobs and economic growth, tariffs can actually harm the economy by hindering innovation and reducing competitiveness. Did we learn nothing in the aftermath of the infamous Smoot-Hawley Tariff Act of 1930?

There is no shortage of misperceptions and skewed thinking surrounding trade deficits and tariffs. Although it is a complicated economic issue, the lame-stream media has treated it as a binary political issue, and not an issue with nuances and trade-offs. For example, there is the rote proclamation that tariffs automatically translate into higher rates of inflation. This is not necessarily always the case. As mentioned earlier, the strength or weakness of the dollar on the foreign currency exchange market will play an outsized role in determining if prices rise or not. Another relevant factor would be the extent the importer (payer of tariffs) of foreign-made products decides to pass on to consumers. Lastly, and most importantly, it ultimately comes down to the behavior of consumers. Consumers always have the option to modify their spending habits by seeking out sales, finding a substitute for a product, or flatly refusing to purchase a product.

The solution to our bothersome trade deficit with the world is both magnificently simple and functionally arduous to carry out. The reason for the deficit can be boiled down to the U.S. as a whole spending more money than it makes. The personal savings rate in the United States averaged 8.45% between 1959 and 2024. This rate currently stands at 2.90%. Thus, boosting the saving rate in our country would bring down the trade deficit. Besides individuals saving more, the federal government needs to get its fiscal house in order. The combination of excessive government and insufficient revenue (tax) collections has fostered larger and larger federal budget deficits. This reduces the national savings rate and raises the trade deficit. A portion of the budget deficit is effectively financed through a rise in the total amount Americans borrow from abroad. An apt analogy would be comparing the government's insatiable addiction to spending money to that of a heroin addict craving a fix. All too often the drug addict kicks the bucket. The same can happen to a nation if the value of its currency continues on the path of debasement. We need sound money.