Trade Deficit Disorder

I have been warning about this for nearly 8 years. My worst fears are now coming true.

Nearly eight years ago, I published an opinion piece in the Financial Times under the title of, “Donald Trump is suffering from trade deficit disorder.” If you want, you can read the piece here.

In a nutshell, I argued that bilateral trade deficits are all but meaningless in a multilateral world. Back then, the United States had trade deficits with 101 nations (2016 data) – today, the number is 106 (latest data for 2023). I stressed that multilateral trade deficits don't arise in a vacuum — that they are out outgrowth of saving imbalances. Back then, America’s net domestic saving rate was 3% of national income (in late 2016) — today, that number is 0.4% (third quarter of 2024). Lacking in saving and wanting to invest and grow, the US must import surplus saving from abroad. It gets that foreign capital by running massive current account and multilateral trade deficits.

That underscores the most insidious aspect of America’s trade policy problem – that there is no bilateral fix for a multilateral trade deficit. Without addressing the domestic saving shortfall — all but impossible to envision considering the outsize budget deficits likely under Trump 2.0 — squeezing one trading partner simply forces diversion to other trading partners. As I have argued repeatedly, it’s like putting pressure on one end of a water balloon — the water simply sloshes to the other end.

Trump did that with tariffs on China in 2018-19, and that is exactly what happened. The Chinese piece of the total trade deficit shrank but, reflecting outsize federal budget deficits which led to a persistent shortfall of domestic saving, the overall multilateral trade deficit rose to new records, driven by trade diversion to Mexico, Vietnam, Canada, South Korea, Taiwan, India, Ireland, and Germany. Moreover, as I detailed in a follow-up piece, the bulk of these beneficiaries of trade diversion were higher-cost foreign producers, effectively resulting in a tax hike on American consumers.

I ended the original 2017 piece in the FT with a warning: “This delusion [trade deficit disorder] must be treated before it is too late.” Alas, I am afraid that now it is, indeed, too late. In human behavior, there is no such thing as a self-healing psychosis. That appears to be the case with a delusional economic policy. There is nothing all that complex in the argument that I have summarized above. It rests on the basics of national income accounting identities — that saving must always equal investment and that the trade deficit is a perfectly natural, albeit exquisitely uncomfortable, outgrowth of any gap between investment and saving. For most macro economists, this is “common sense.”

Not so for Donald Trump. Not only has he dug in his heels on the specious argument that underpinned the misdirected trade policy of his first term, but he has upped the ante on this delusion by underscoring his infatuation with “beautiful tariffs.” He incorrectly insists that tariffs are the most effective way to penalize our trading partners who dare to run bilateral trade deficits with the United States. He makes the ludicrous claim that they will pay that penalty — ignoring yet another common sensical point that tariffs are paid directly by US-domiciled importers. Deepening this sense of delusion, as I pointed out recently in another piece, Trump has signed an executive order aimed at establishing an “External Revenue Service” that he incorrectly claims will be funded by the tariff revenues from our deficit trading partners, especially China, Canada, and Mexico. As I said, the trade delusion in Trump’s case, has taken on a life of its own.

Over the weekend, Trump flooded the news feeds with threats of imminent tariff hikes on those same three countries. Like the on-again, off again bluster regarding the Federal grants and loans spending freeze he fumbled last week, he has just backed off on the Mexico tariff threat — at least for a month. Apparently, he is in conversations with the Canadian government that may or may not go the same way.

Don’t hold your breath. Even if Donald Trump backs down on Canada or perhaps pulls a rabbit out of the hat with China, the damage has been done. He was the first to extol the virtues of the US-Mexico-Canada-Agreement of 2020 as the greatest trade deal in history. Yet nearly the first thing he does when he gets back in office is to threaten to tear up this same fabulous deal for concocted political reasons. That’s especially the case when it comes to Canada, America’s largest trading partner; Trump claims that tariff hikes on Canada can be justified by fentanyl traffic and illegal immigration. Never mind that there is no evidence in support of those allegations — Canada accounts for just 0.2% of fentanyl traffic into the US and just 1.4% of illegal immigration since 2020. Given Trump’s willingness to shred his favorite deal on the basis of purely fabricated claims, which nation would ever trust him again?

Trump’s advice to Canada is to relax and simply “become our Cherished 51st State.” After all, he claims, as a state, Canadians would enjoy lower taxes, far better military protection, and avoid having to pay any of those nasty tariffs. And he has the audacity to send that blatantly false message on his personal platform that he calls Truth Social.

In has now been two weeks since the inauguration of Donald Trump. For many, it seems like the world as we once knew it has been turned inside out in just fourteen days. It’s not just his delusional trade and tariff policies but also his vindictive assault on the Department of Justice and the FBI, his dismantling of America’s foreign aid infrastructure, his penchant for territorial expansion, and his empowerment of the extra-legal Musk brigade to grab control of the US Treasury’s funding mechanism.

Delusion is an insidious psychosis. That much is, indeed, common sense. Sadly, that’s what now afflicts our great nation.