Trade, Trade Deficits, Secular Stagnation, and a Good Use for Excess Savings

March 8th, 2017 at 6:03 pm

Three recent articles caught my eye re international trade. First, there’s Neil Irwin reprising his theme, an important one, that the trade deficit isn’t a report card. Sometimes such imbalances are a problem, other times they’re not, so; as the balance of payments serenity prayer says: “Keynes, give us the wisdom to tell the difference.” Second, an oped by the Trump Administration’s trade guy Peter Navarro, who clearly does view the trade deficit as a report card that’s been bringing home F’s for about 40 years. Finally, an article about internal investment in China that needs to be seen in the context of the other two pieces.

First, Irwin’s correct that trade deficits can be harmful or benign. But how can we know which is which? A compelling answer, offered in this long essay by Michael Pettis or this distillation by Matthew Klein, involves the other side of the trade deficit, i.e., the capital account surplus. In order to finance the consuming of more than we’re producing—the trade deficit—we must borrow from abroad. So the trade deficit is always matched dollar-for-dollar by a capital surplus. What Pettis et al explain, and this is key to all three of these pieces, is that the balance-of-payment identity works in both directions.

That is, world trade must balance, so when some countries produce more than they consume, or save more than they invest, other countries must do the opposite—consume more than they produce and spend more than they save. Yes, when we spend more than we save, that adds to our trade deficit. But when other countries save more than they spend, and export those savings our way (capital inflows), that too drives our trade deficit. Thus, our trade deficits are not, as scolds often tell us, exclusively a function of shop-till-you-drop Americans buying favorably priced stuff from abroad. They’re also driven by capital flows from countries that maintain trade surpluses. It makes no more sense to yell at Americans for dis-saving than it does to yell at Germans (and the Taiwanese, the Koreans, and others) for saving too much.

We still haven’t determined “the wisdom to tell the difference” as per when trade deficits are harmful, and we’ll get to that. My first point is that Navarro does not seem to understand this nuance, and thus falls into the trap that Irwin warns of: trade deficits subtract from growth, so they’re always and everywhere bad. This leads him down all sort of false paths. The Chinese, the Mexicans, and whomever else we run a bilateral deficit with are the enemies.

But he’s missing the forest for the trees. Follow the money–the capital account–not just the individual trade balances. As long as the world’s excess global savings continue to flow to our shores, our trade deficit will persist, and going after bilateral deficits one at a time becomes a game of whack-a-mole that we can’t win.

Pettis points this out in his discussion of Mexican/US trade. Navarro and Trump will argue that we run a deficit with Mexico which must be balanced (perhaps through renegotiating the NAFTA). But Mexico also runs a trade deficit. Pettis:

This means Mexico is importing excess global savings and, rather than contributing to global and U.S. trade imbalances, is in fact helping to absorb them. If Washington takes steps to reduce or eliminate Mexico’s bilateral surplus with the United States, and this causes net capital inflows into Mexico to decline, Mexico’s [trade] deficit must decline, regardless of what happens to its bilateral surplus with the United States.

The paradoxical consequence could very easily be a wider American trade deficit even as the American trade deficit with Mexico contracts. This may seem counterintuitive, but only to those for whom international trade is the sum of independent bilateral trade balances. Once we recognize that bilateral trade reflects the complexity of trade in the global economy, and not the sources of the trade imbalances it becomes clear that Mexico is not a source of American trade imbalances, and is in fact far more likely to be providing relief.

You might ask, as one reader did: why does Pettis assume foreign savings would flow here as opposed to some other country? Good question, but Pettis’ assumption is a fair one. The dollar is still the world’s main reserve currency, and especially now, given our stronger relative growth rates and Fed’s “normalization” (rate hiking) campaign, dollar demand is strong. We also have the most liquid, accessible financial markets, and finally, we consume a far larger share of GDP (70%) than Europe (55%) or China (35%!–the flipside of their large trade/savings surplus).

At any rate, these dynamics are why the China article caught my eye. The piece tells of China’s “…$300 billion plan to become nearly self-sufficient by 2025 in a range of important industries, from planes to computer chips to electric cars, as it looks to kick-start its next stage of economic development.” But various officials and business reps from elsewhere, especially those that service the Chinese market, are crying foul, arguing that the program, with its heavy government subsidies “would force out competitors from abroad and lead to government-subsidized global players that would compete unfairly.”

But if China is reinvesting a chunk of its own savings in its own economy, that means less capital flowing into the US, and less pressure on our trade deficit. The more they absorb their own savings (of which, to be clear, $300 billion is a small piece), the less countries like the US and the UK will continue to play our symbiotic consumer-of-last-resort role.

True, it matters what they do with the money, and there are lots of examples of China’s over-investment in inefficient sectors and projects. But as Brad Setser convincingly argues, encouraging countries with large surpluses (which must show up as deficits somewhere else) to engage in more internal investment is a far preferable way to reduce our own imbalances than tariffs and trade barriers (though Brad’s thinking more about investing in public goods than in private industry).

So, enough beating around the balance-of-payments bush: when are trade deficits a problem? Again, we must come at the problem from the side of the capital flows—the borrowing from abroad—that support our trade deficits. If we have truly productive uses for that capital, then trade deficits can be a plus. If there exist underfunded investments that generate a return higher than the rate of interest, the surplus on the capital account can be put to good, productive use. If such investments do not exist, there’s an all-to-good chance that the capital flows into a wasteful, damaging asset bubble.

Second, Navarro is not wrong to worry about the drag on demand from negative net exports, but only when there’s nothing in the pipeline to offset it. The Federal Reserve can lower interest rates to offset the drag, but not if they’re near zero, or in rate-raising mode, both of which conditions apply today. Fiscal policy can pick up the slack, but not if Congress refuses to step up.

So yeah, today’s trade deficits are a problem. They’ve not been large enough to keep the economy from growing and unemployment from falling, but remember, it’s year eight of an economic expansion and we’ve still not fully closed the GDP output gap (and that’s even the case as potential GDP has been lowered). In the absence of offsets, we could have used that extra demand.

One final thought. Hovering over this conversation is the specter of secular stagnation, a persistent demand shortfall that stems from excess savings colliding with insufficient investment opportunities. Note again the role played by excess savings, which, as I’ve stressed, are the flip side of our trade deficit. But what if we were to take a deep dive into public infrastructure investment – for example, green technology? Suppose we were to channel the excess savings from the surplus countries into standing up an industry that developed the next generation of batteries for storing renewable energy.

I know. This Congress and this president aren’t going there. But given the existential threat of climate change, or for that matter, the general state of our public goods, I find it awfully hard to accept the contention that there’s nothing productive in which to invest the excess savings surplus countries continue to send our way.

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10 comments in reply to "Trade, Trade Deficits, Secular Stagnation, and a Good Use for Excess Savings"

  1. Kevin Rica says:

    Let’s not make this into an excuse just to borrow the surplus Chinese savings and use them to build American bridges with Chinese steel when we could have made the steel ourselves. Without the inflow of Chinese funds and the trade deficit, we could finance more public spending from the higher taxes on higher GDP.

    The NYT article (China’s Plan to Build Its Own High-Tech) is NOT reassuring. China’s investment in high-tech industries is squarely aimed at the traceable goods sector – building the capacity to export even more goods and reduce their reliance on imports. A lot of Chinese corporate acquisitions simply finance their current trade surplus and prepare to produce a larger trade surplus in the future. This is not sustainable. If China was investing in better health care, more retirement facilities for their aging population, and cleaning up their air (putting scrubbers on all their power plans) and water (forcing firms to stopping dumping industrial waste in their rivers), and generally providing more consumption goods and services to their own workers, THAT would be a step forward.

    But China is not doing those things because it would involve redistributing income away from the Communist Party (their motto: Four Legs Good, Two Legs Better!). As long as China remains a weird, authoritarian plutocracy under the Communist Party, they will not share the savings and it will be forced outward.

    The only way forward for Navarro and Trump will be to defy orthodoxy and impose restrictions on inbound investment flows from trade-surplus countries like China, Germany, and Japan. They don’t want those savings and we don’t either. Those inflows finance their trade surpluses and our trade deficits. Without those inflows, only our exports can pay for their exports (our imports). Without the drag on aggregate demand, America’s economy grows faster.

    So, if the Administration is serious about reducing the trade deficit (and they have the moxie!), they should forget about trade deals and restricting imports of goods and services, and restrict the capital flows that finance the trade imbalances.

    That’s right! Let’s say it! Capital controls! – but only if you have an Administration with the moxie!

  2. Doc at the Radar Station says:

    I agree with Kevin about capital controls. Put ’em back in. Jared, you should post about the “Triffin Dilemma” in relation to this discussion:

    Also, a quick summary of how Bretton Woods ‘worked’ would be interesting in that context.

  3. Ed Brown says:

    Mr. Bernstein,
    I am struggling to understand these issues. I do think that in the long run, one cannot intelligently determine macroeconomic policy without maintaining an awareness of electoral politics. If we identified the optimal economic policy, but it was unpopular, and we also identified a slightly less optimal, but still good, economic policy, which was popular, we would be wise to implement the second policy. If we chose the first policy, it would get overturned at the next election.

    For this reason, I think we would be wise to have balanced trade. I believe it would be popular and therefore sustainable. I think having unbalanced trade leaves room for the common man to blame his ills on the system and decide to vote for people who will fix it.

    I also think that the trade deficit has hurt the common man in the US over the last 8 years – as you pointed out above. This having been the case, it is curious that the Democratic Party, which used to represent the working class, generally were not focused on mitigating the trade deficit issue. Obama was in favor of TPP, Clinton was as well (in my view her statements to the contrary were not credible). Ironically, the Republican party’s candidate at least talked about fixing the problem. Perhaps his recommended medicine is worse than the disease, but we can’t expect every voter to be a macroeconomic expert.

    The whole point of my long-winded screed above is to make the case that the Democratic Party needs a better trade policy. Whether it is capital controls or a Buffett-type trade policy, I don’t know. I am hoping you could evaluate the Buffett plan from both a political and economic perspective. If the Democratic Party is to settle on a new trade policy, we need people like yourself to explain what that policy ought to be. Most of us lack the economic intelligence to make a compelling case. You do not.

    Thank you and best wishes.

  4. Tom in MN says:

    Nice explanation, thanks.

    Clearly lots of confusion here, on the flip side Germany thinks all other EU nations can also run trade surpluses and save as much as they do. The connection to secular stagnation is a good one; no one seems to ever worry about too much savings. Saving is always seen as virtuous, but that is clearly not the case. Personal financial advice always tells people that they must save (for college, retirement, etc) yet that advice is often wrong for the economy as a whole. Extrapolating personal fiance advice to the economy as a whole seems to be a recurring problem. This is also the same reason someone who has run a business does not necessarily have any idea how to run the country’s economy.

  5. jo6pac says:

    I’m sure this will happen in the new trump Amerika;)

  6. Smith says:

    This very long post is unneeded. Trade is so simple that even Donald Trump could understand it, as could the average Joe in Wisconsin, Michigan, and Pennsylvania, not to mention Mrs Joe.

    Trade deficits bad. Do something. Trump said he’ll do something. People voted for him.

    Irwin’s take is not particularly enlightening, to say the least and except for the inconsistent take on the Mexican trade deficit, the Pettis piece points the way towards protection. Mostly he says unless the U.S. is a developing country without domestic access to capital (obviously not), out trade deficit causes unemployment and asset bubbles.

    He does say this about Mexico (because it absorbs a 2.8 percent trade deficit overall):
    “Mexico is not a source of American trade imbalances, and is in fact far more likely to be providing relief.”
    This I do not believe is true. It’s $1 trillion economy, with a $60 billion U.S. surplus, but $28 billion overall deficit. The $60 billion removed would create an unsustainable nearly $100 billion deficit (10 percent of GDP), and investment might plummet sending the net inflow of $28 billion or more elsewhere. Even if that negates 1/2 the $60 billion, the U.S. still comes out ahead. If the Mexican economy collapsed, all bets are off, but then we have different problems. There can be no realistic argument not to make adjustments just because it would strain the Mexico economy (which is much in need of reform, why do auto workers only make $5/day?).

    How well does Pettis know the Mexican economy?
    “In addition to trading and capital markets, Pettis has been involved in sovereign advisory work, including for the Mexican government on the privatization of its banking system”
    I guess he knows the banking system.

    The illogical assumption that trade can’t or shouldn’t be addressed bilaterally is wrong.

    Worth noting too, the denial about China’s intentions to become immune to outside influence while dominating the world is difficult to comprehend. It’s not like they are hiding it. They come right and say, “Don’t tell us how to run our country” and “We will dominate our domestic markets with domestic industry, while becoming leaders in every technology” No comparative advantage theory of trade needed here.

    I wish I could curse to express the anger and disappointment over the opposition’s response to Trump’s moves on trade. It seems to be, ok, he got some things right, but we can’t admit that because he’s Trump (often racist, and often wrong).

    • AngloSaxon says:

      You should take your own advice. Trade deficits are needed to finance US debt. Period. Try and contract them and you get the next depression.

      Nor did Trump get many votes from “trade” it was all evangelical, I mean, they had a woody for the guy.

  7. SPENCER says:

    If you think the driving force behind the trade deficit is the savings-investment gap it becomes very obvious that what has destroyed manufacturing jobs is the Republican tax cuts that shifted the saving-investment gap from a relatively minor item to a huge problem. Moreover, they are repeating the same mistake under Trump.

  8. genauer says:

    A thought from Europe.

    This continent is mature, rapidly ageing, and that means that large external or government debt ever rising is not OK.

    Even with the recent Current account surpluses, the cumulative NIIP
    is still negative, and very negative for a couple of countries.

    As a whole, excluding UK, Germany, Dutch, a whooping 34% GDP negative.
    That needs to be worked down, NOW.