Former President Donald Trump continues to be fixated on the trade deficit of the United States and the health of the U.S. manufacturing sector. When he was president, one of Trump’s policy initiatives was to reduce the trade deficit by raising tariffs. Trump also said that tariffs would help protect employment in the manufacturing sector from unfair foreign competition. He failed on both counts. During Trump’s presidency, the trade deficit increased to its highest level in a decade. The manufacturing sector also continued to lose jobs but not because of imports.
For decades, U.S. manufacturing, as a percentage of gross domestic product, has been stable at around 12%. However, employment has declined because manufacturing productivity has increased. Manufacturers now produce more per unit of labor. U.S. manufacturers are globally competitive. They don’t need tariffs to compete. Nonetheless, the Trump campaign continues to make the false claim that tariffs will reduce the trade deficit and help stabilize the fiscal deficit.
Trump does not understand that the U.S. trade deficit is a function of two major factors. The U.S. imports more than it exports because the U.S. consumes too much relative to domestic production. In plain language, America’s demand for goods exceeds the domestic supply of goods. We import the difference between our demand and what we produce. But the U.S. trade deficit is nothing new. The country has been running trade deficits since the 1970s. Not coincidentally, the federal government has been running fiscal deficits since the 1970s.
Our fiscal deficits drive the trade deficit. Deficits reduce savings. Fix the federal deficit and the trade deficit will shrink. But fixing the federal deficit requires a combination of spending restraint and higher taxes. Moreover, a balanced federal budget would mean that the U.S. would not be held hostage to foreign capital.
That matters because foreign investors could sell Treasurys because of fears about out-of-control spending. International investors worry about the ability of the federal government to service the debt. In 1970, foreign investors owned 5% of U.S. debt. As deficit spending increased, foreign holdings of U.S. debt increased. Now, non-American entities hold 29% of the country’s debt, public and private.
We already see nervousness among overseas holders of Treasurys, which is expressed by a rising demand for gold by the central banks of other nations. It is no coincidence that the price of gold rises as the federal deficit increases. The U.S. is able to run consistent trade deficits because the U.S. dollar is the reserve currency of the global economy. Outside of intra-Europe trade, about 80% of international trade is financed with U.S. dollars.
Moreover, international investors and the central banks of our principal trading partners are happy to hold Treasurys as a store of value. In effect, Treasurys are modern-day gold. But the luster of Treasurys diminishes as federal deficits increase.
Tariffs will not reduce the trade deficit. The only way to reduce the trade deficit is to increase domestic savings. Either households dramatically increase savings and reduce consumption, or the federal government balances the budget. There is no other way to reduce the trade deficit.
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What Trump does not disclose about his planned tariffs is that they would be a large tax on consumption. Tariffs would hit households hard, maybe by reducing individual household consumption by as much as $2,600 a year.
The U.S. must get its fiscal house in order, and tariffs are not the answer.
James Rogan is a former U.S. foreign service officer who later worked in finance and law for 30 years. He writes a daily note on the markets, politics, and society. He can be reached at [email protected].