The US Trade Deficit: Myths and Realities

Abstract

ABSTRACT: A policy priority of the US government is to reduce America's long-standing trade deficit. Economic planners in the Trump administration blame the postwar world trading system for harming the US economy and hope to change it through wide-ranging tariffs and other measures. Three prominent myths underlie the narrative that the United States has been victimized by trade partners. The first holds that trade liberalization that has left the United States open to mercantilist foreign practices is a primary cause of the aggregate US trade deficit. The second is that the dollar's status as the premier international reserve currency obliges the United States to run trade deficits to supply foreign official holders with dollars. The third is that US deficits are caused entirely by foreign financial inflows that America must accommodate by consuming more than it produces. This paper shows that the realities are more nuanced. While foreign and domestic trade policies can affect both imports and exports separately, they are not principal drivers of their difference, the trade deficit. The United States can supply the world with dollars without trade deficits. Finally, the trade deficit reflects the interplay of foreign and US macroeconomic factors (including China's saving rate and the US government budget deficit) and often US factors are dominant. Higher federal fiscal deficits, for example, will raise US trade deficits despite more import tariffs.