Comments at Public Hearing on US Trade Deficits: We Know What Causes Trade Deficits

Comments presented at a public hearing held by the US Department of Commerce and the United States Trade Representative, as part of the study ordered by the Presidential Executive Order Regarding the Omnibus Report on Significant Trade Deficits

May 18, 2017

Thank you for giving me the opportunity to comment today.

First, I would say that it is critical for you in drafting this report to decide if it is to be about (1) the causes of the overall US trade deficit or (2) a catalog of unfair foreign trade practices that distort trade balances in specific categories of trade.

If it is the latter, then it would seem to have a lot of overlap with the United States Trade Representative’s (USTR) comprehensive annual National Trade Estimate Report on Foreign Trade Barriers.

I am going to focus on the former topic. The overall trade deficit reflects our net borrowing from the rest of the world and the US net debt to foreigners is rising at an unsustainable rate. We should take steps to narrow the deficit and stabilize our debt.

I note in passing that focusing on bilateral trade deficits does not help us to understand the source of the overall deficit. For example, we have a bilateral trade surplus with Singapore. But Singapore, in turn, has trade surpluses with many countries with which we have bilateral deficits. It is a country’s overall trade balance that ultimately matters. Singapore has one of the world’s largest trade surpluses, supported to a large extent by currency manipulation that holds the dollar up. It is a significant contributor to the US overall trade deficit, despite the fact that we have a bilateral surplus with them.

Now I don’t dispute that unfair foreign trade practices do harm US producers. You will undoubtedly hear a lot about that today. But unfair foreign trade practices have no measurable effect on the overall US trade deficit.

To understand why, consider imposing a prohibitive tariff or outright ban on all US steel imports, worth about $34 billion last year. You might think this would narrow the trade deficit by $34 billion. But this policy also would cause the dollar to rise about 1 percent, not a large amount, yet it is enough to cause nonsteel imports to rise and all exports to fall by roughly $34 billion, leaving the trade deficit unchanged.

Thus, protection helps the protected industry at the cost of all other industries.

Two charts in my submitted comments show that different measures of trade barriers have no discernable correlation with trade balances across countries. Countries with higher tariffs do not have higher trade surpluses.

If trade barriers have no effect on the overall deficit, what does?

My new book with Fred Bergsten talks about the most important factor behind record global trade imbalances in recent years: namely, currency manipulation by foreign governments.

We estimate that in 2007, at the peak of the imbalances, all of China’s trade surplus and 35 percent of the US trade deficit could be explained by currency manipulation.

Another 25 percent of the US trade deficit was explained by the US government budget deficit.

Two charts in my submitted comments display the strong positive correlation of currency manipulation and budget balances with trade balances across countries.

Why do these policies matter so much?

The key is that they affect saving and investment. As others undoubtedly will point out at this hearing, we cannot have a trade deficit unless we invest more in factories and houses than we save, borrowing the difference from the rest of the world.

Government budget surpluses are part of national saving—budget deficits are negative saving.

Currency manipulation floods US financial markets with capital from foreign governments. This pushes up the dollar and causes the Fed to hold interest rates down. Low interest rates encourage investment and discourage saving, thus supporting the trade deficit.

Although currency manipulation is not nearly as widespread today as it was a few years ago, the policy actions Fred Bergsten and I propose, including countervailing currency intervention against foreign manipulators, would help immediately to narrow the trade deficit by pushing the dollar down somewhat.

A major factor holding the dollar up right now is the market’s expectation that foreign governments are waiting in the wings to resume buying dollars if needed to maintain their trade surpluses. In the event of any future downward pressure on the dollar, such official purchases would allow private investors to unload their dollar portfolios with only minor losses. This effective “dollar put option” makes dollars less risky to hold, keeping the dollar overvalued. Eliminating expectations of future currency manipulation through the policy actions we propose would eliminate this dollar put option and cause the dollar to decline immediately.

It would also help if the President and the Treasury Secretary would formally renounce the strong dollar policy and instead adopt an “appropriate dollar policy” aimed at keeping the US trade balance reasonably close to zero.

Thank you.