The Trouble With the Trade Surpluses
Everything is about balance. Work-life balance, balanced relationships, a balanced diet. Economists also talk a lot about balance. A balanced budget or balanced trade.
The Trump administration focuses less on a balanced budget, but is very concerned about balanced trade. At this moment, trade is very unbalanced, with the United States running a deficit of $531.5 billion with the rest of the world in 2015.
On cue, President Donald Trump and his advisers, during his campaign, started picking fights with the biggest offenders (in other words, the countries with the biggest trade surpluses): China and Mexico.
In 2015, China had a $362 billion trade surplus with the United States—more than two-thirds of the total U.S. deficit. Mexico had a $74 billion surplus, which, given the size of its economy, is relatively larger than the Chinese one.
The posturing continued after Trump took office, but now his administration has identified an additional enemy: Germany, which netted a $77 billion surplus with the United States in 2015.
“Germany … continues to exploit other countries in the EU as well as the U.S. with an ‘implicit Deutsche Mark’ that is grossly undervalued,” Trump’s trade adviser Peter Navarro told the Financial Times.
A currency’s fair value is a fairly subjective term, but it is true that the European Central Bank (ECB) keeps increasing its balance sheet, while the Federal Reserve (Fed) stopped printing money in 2014. Over the same period, the euro lost 23 percent against the dollar.
Even Germany’s Finance Minister Wolfgang Schäuble agrees: “The euro exchange rate is … too low for the German economy’s competitive position,” he told German daily Tagesspiegel. “When ECB chief Mario Draghi embarked on the expansive monetary policy, I told him he would drive up Germany’s export surplus. … I don’t want to be criticized for the consequences of this policy.”
Draghi subsequently denied the allegations of currency manipulation in front of the European Parliament.
Japan, previously unscathed, also got its share of criticism. After all, it prints even more money than Europe and the yen has lost around 50 percent against the dollar since the beginning of 2012. Japan had a trade surplus of $83 billion with the United States in 2015.
“You look at what China’s doing; you look at what Japan has done over the years. They play the money market, they play the devaluation market, and we sit there like a bunch of dummies,” Trump said, during a meeting with pharmaceutical executives on Jan. 31.
Unlike his German counterpart, the Japanese official in charge of foreign exchange policy, Masatsugu Asakawa, thought Trump’s remarks were off the mark and that monetary policy is “for the domestic purpose of beating deflation,” according to Bloomberg News.
Whatever it is that Japan wants to achieve, here’s what the Trump administration is concerned about.
Importing $531.5 billion more in goods and services means those goods and services aren’t produced in the United States. Mathematically, this subtracts from GDP and therefore economic growth. On the ground, it means fewer jobs and less business investment in the United States.
What it also means is that the United States has to make up for the $531.5 billion by giving foreigners a claim on U.S. assets. This is the same as buying a car with your credit card. You don’t have the money now, so you borrow it, and you have to pay your bank back later.
But what do you use to pay it back in the future? You, as an individual, have to use your wages to repay the credit card bill. To settle its external debt, the United States, as a country, has to export more goods and services than it imports in the future.
At this point, this scenario is highly unlikely, which is why surplus countries should take heed. On the surface, it looks like they are gaining with their paper surpluses, accumulating savings in U.S. dollars.
But countries like China, Germany, Japan, and Mexico are exchanging current production, things of definitive value, for claims on future production from the United States, like U.S. Treasurys, corporate bonds, stocks, or real estate.
In other words, if Germany sells a couple of BMWs to the United States, instead of getting back one Caterpillar Excavator in a direct exchange if the trade was balanced, it gets a couple of Treasury bonds. But the bonds merely reflect the promise to convert them into Caterpillar Excavators plus interest in the future, so there is a risk that Germany won’t get back real products for its real BMWs.
This leaves the surplus countries in a more vulnerable position than the deficit country. Yes, their employment is temporarily high, and they have strong domestic business investment fostering innovation.
But what if the United States decides to stop importing or make imports much more expensive, as the Trump administration is threatening to do with its border tax proposal?
The factories will stand idle, the workers will be laid off, and the business investment geared to the export sector will lose value.
On the U.S. side, the consumer will have to bear higher prices and probably cut down on consumption in the short term. Supply chains for domestic U.S. companies will be disrupted. In the long term, production will start again in the United States, and more workers will be employed, being able to afford more consumer products again.
There is another issue with accumulating too many U.S. promises to pay through persistent current account surpluses. The United States can simply decide to default on its promises. This can be done via outright default (unlikely) or a devaluation of the dollar.
Suppose Germany sells its BMW for $100, worth 93 euros at current exchange rates. If the dollar devalues by 50 percent, as it did after the 1985 Plaza Accord, for example, you would only get 46.5 euros for your $100, plus a paltry interest payment. Who is losing now?
And the devaluation scenario comes on top of investment risk. A study by the German Institute for Economic Research shows that Germany lost 20 percent of its economic output, hundreds of billions of dollars, because of bad investments during the period from 2006 to 2012.
So in the long term, it’s in the interest of the surplus countries to get trade back into balance again. In nature and economics, things balance out over the long term anyway. The only question is how much short-term pain it causes.