Twin Deficits: Economics Meets the Law
A stunning Court ruling does not negate the worrisome interplay between America's budget and trade deficits.
The twin deficits are back. As was the case in the 1980s, a powerful interplay is at work between ever widening US budget and trade deficits. But unlike the 1980s, the US judicial system has weighed in. A unanimous ruling by the US Court of International Trade has just struck down a large swath of Trump’s misdirected tariffs purportedly aimed at the trade deficit. But with the budget deficit likely to be swollen by “One Big Beautiful Bill,” America’s twin deficit problem is here to stay.
As always, context is key. In this case, that context is an issue I have been droning on about years: America’s seemingly chronic shortfall of domestic saving. Lacking in private saving, America’s budget deficit is the functional equivalent of a saving deficit. And what a deficit it is! In the fourth quarter of 2024, the net national saving rate — the combined saving of US businesses, households, and the government sector — was just 0.6% of national income, far short of the post-1960 average of 5.5%. Net saving has critical implications for long-term US economic growth. It measures the portion of national income available to fund growth in productive capacity, after allowing for wear and tear as well as technological obsolescence of existing plant and equipment. A near “zero” net national saving rate means the United States is saving only enough to cover the depreciation of its worn-out capital stock, leaving it with essentially no domestic saving to support longer-term economic growth.
Net saving also has critical implications for how the so-called twin deficits fit into the macro equation. Lacking in domestic saving but wanting to invest and grow, the US must import surplus saving from abroad, running massive balance-of-payments and trade deficits to attract the foreign capital. A persistent trade deficit tells us that the US has long been consuming more than it produces. It’s hardly a secret as to how America has gotten away with this. Owing in large part to the strength and “exorbitant privilege” of the US dollar as the world’s dominant reserve currency, we have been able to live beyond our means for decades, as those means are determined by domestic production and income generation.
The twin deficit debate is not without controversy. As can be seen in the chart below, the year-to-year correlation between America’s net national saving rate and the current account balance is far from precise. However, the co-movement in these twin macro imbalances has been striking since early 1982 when the US current account first went into negative territory; it has remained in deficit ever since — apart for the first two quarters of 1991 associated with external funding for Operation Desert Storm and the liberation of Kuwait. Over that 42-year period, America’s net domestic saving rate has declined by 5.5 percentage points while the current account balance has deteriorated by a little over four percentage points of GDP. Yet as critics of the twin deficit saga have noted, so far, these ominous trends have not had major adverse consequences.
Those days of twin-deficit immunity may now be drawing to an end. The outsize Federal budget deficits of Trump’s “One Big Beautiful Bill Act” (OBBBA) are about to drive subpar saving even lower, quite possibly into negative territory. That points to a further widening of the US trade deficit, precisely the opposite of the stated objectives of Trump’s tariff policies to reduce the trade deficit. That’s right, Trump’s two signature economic actions have been working at cross-purposes all along. It turns out there was a constitutional disconnect as well.
The stunning verdict of the Court of International Trade turns the tariff debate inside out. It repudiates Trump’s core premise that so-called global reciprocal tariffs could be justified under the purview of the International Emergency Economic Powers Act of 1977 (IEEPA). According to a While House fact sheet issued on Liberation Day, the emergency, in this case, was “the large and persistent trade deficit.” Yet as the Court found, the President lacks the constitutional authority to circumvent the responsibility of the US Congress, both in determining a state of economic emergency as well as in imposing a broad tariff-setting “remedy.” The Court not only threw cold water on the notion that a trade deficit qualifies an emergency — arguing instead that it falls under “a narrower non-emergency statute”— but drawing on Federalist No. 48 (James Madison), the ruling stressed, “that we do not read IEEPA to delegate unbounded tariff authority to the President.”
While I am hardly qualified to weigh in on the legalities of the tariff debate, I would underscore two economic considerations that are quite relevant to Trump’s overreach on tariffs. One, there is no case for declaring an economic emergency in a nation that has historically low unemployment and inflation. This is illustrated below by the “Misery Index,” a simple arithmetic sum of the civilian unemployment rate and year-over-year changes in the headline CPI. I have made this point repeatedly and it was underscored earlier today by Paul Krugman in his latest blog posting. Second, the twin deficit framework stressed above demonstrates that trade deficits are very much a problem of our own making — a by-product of a chronic US saving deficit that is likely to get a good deal worse under the “Big Beautiful” outsize budget deficits of Trump 2.0.
How bad is it likely to be? That takes us into the weeds of the preliminary “fiscal scoring” of OBBBA by the nonpartisan Congressional Budget Office. Based on legislation reported out of the House Budget Committee on May 18, the CBO calculates that OBBBA will add approximately $2.3 trillion to the cumulative 10-year Federal (on-budget) deficit trajectory over the 2025-34 period. This works out to an 11% increment over the CBO’s earlier baseline — enough to add at least 0.6 percentage point to the average deficit share of GDP over the next ten years; that means, under OBBBA, budget deficits as a share of GDP would soar to an average of -6.4% through 2034, compared with the CBO’s previous baseline estimate of -5.8%.
That is also a reasonable approximation for likely impacts of OBBBA on the US current account deficit in the years immediately ahead. The US current account deficit as a share of GDP stood at -4.1% in late 2024, more than double the average shortfall of -1.7% recorded since 1960. If the current account deficit were to widen by another 0.6 percentage point — reflecting the deterioration in the net domestic saving rate associated with CBO’s initial scoring of OBBBA — it could well threaten the -5% threshold, taking it close to the GFC-like depths of 2008-10. That would be a worrisome outcome for two key reasons:
No cushion. Today’s twin-deficit situation is already considerably worse than it was back the 1980s, when this problem first became evident. The net national saving rate, which stood at just 0.6% in late 2024, averaged 5.9% from 1980 to 1986. Similarly, the US current account deficit of -4.1% of GDP in late 2024 is more than three times the -1.3% average share from 1980 to 1986. Unlike the 1980s, America has no longer has a cushion protecting itself from twin-deficits vulnerability.
The dollar. This raises an important question about the ease by which the United States has been able to fund its large and growing current account deficit over the past several decades. So far, the Teflon-like allure of the US dollar has convinced foreign creditors not to demand special treatment for their seemingly open-ended willingness to satisfy America’s enormous external financing needs. In today’s more serious twin-deficits climate that may not be the case; fearful of Donald Trump’s alliance-busting anti-globalism, increasingly skittish foreign investors have become intrigued with a “sell America” mindset that may force concessions in the terms of US external financing. That implies the distinct possibility of significant downward pressure on the dollar and/or upward pressure on longer-term Treasury yields.
All in all, the interplay between Trump’s fiscal and tariff policies underscores the cognitive dissonance of America’s new twin deficit affliction. Thankfully, the courts have weighed in on the legality of Trump’s purported tariff solution to a concocted economic emergency. If only the Congress would step up and do the same. Unfortunately, the One Big Beautiful Bill virtually guarantees the persistence of large budget and trade deficits for as far as the eye can see. That could well evoke a tough verdict from a different court, as financial markets come to grips with America’s new strain of twin deficits.