Trade Deficits and Budget Deficits
After reading my most-recent letter sent to the Washington Post, Phil Gramm called me and left a voicemail message. (When he called I was in class.) He told me, correctly, that in my letter I failed to “put the final nail in the coffin” of the case that so-called “U.S. trade deficits” are phenomena that Americans should fear. That final nail is pointing out that when the U.S. government ran budget surpluses in 1998, 1999, 2000, and 2001, the real value of U.S. trade deficits rose.
Let me explain.
Government-budget deficits are genuine deficits; they necessarily put all taxpaying citizens of the country further into debt. In contrast, “trade deficits” are not genuine deficits. These “deficits” do not necessarily result in further indebtedness. In practice, some amount of “trade deficits” becomes debt, but not all of it does.
When trade deficits do result in greater indebtedness, they do so in one of two ways. One is when private individuals voluntarily borrow money from foreigners. If I, an American, borrow one-hundred U.S. dollars from a resident of Germany, the U.S. trade deficit is made $100 larger than it would otherwise be, and I am $100 in debt to a foreigner. Note that my increased indebtedness does not pull any other American into further indebtedness.
The second way that trade deficits result in greater indebtedness is when the government borrows money from foreigners. When such borrowing occurs in the U.S., all American taxpayers – current and future, and whether they like it or not – are pushed by their government into greater indebtedness to foreigners.
It is typically said that higher U.S. government budget deficits increase U.S. trade deficits, as foreigners are among the purchasers of U.S. treasuries. And so it is also typically said that one way to reduce U.S. trade deficits is to reduce U.S. government budget deficits: Reduced borrowing by the U.S. government means reduced purchases of U.S. treasuries by foreigners and, hence, smaller U.S. trade deficits.
While I decry the U.S. government’s inexcusable and dangerous fiscal incontinence, it’s not necessarily true that reductions in the size of U.S. government budget deficits will reduce U.S. trade deficits. This outcome might happen. But it’s possible that the opposite will occur – namely, greater fiscal responsibility by the U.S. government might cause U.S. trade deficits to increase. This counterintuitive outcome would occur if global investors judge improved fiscal policy in the U.S. as contributing to a stronger economy in the future. The anticipation of a stronger economy in the future might well heighten foreigners’ eagerness to make equity investments in the U.S., to buy more American land, or even to hold dollars – none of which increases Americans’ indebtedness but all of which increase U.S. trade deficits.
The U.S. experience of 1998 through 2001 is consistent with this latter possibility.
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