March 5, 2018
The Expected Widening in the U.S.
Federal Budget Deficit Has Trade Protectionist Implications
With the recent U.S. congressional passing and
presidential signing of the Tax Cuts and Jobs Act of 2017 and the Bipartisan
Budget Act of 2018, the federal budget deficit is projected to increase in the
next few years. According to projections by the nonpartisan Committee for a
Responsible Federal Budget, the U.S. federal budget will rise from $665
billion in fiscal year (FY) 2017 to $753 billion in FY 2018 and $1.1 trillion in FY 2019. Unless these
increased federal budget deficits are financed out of increased U.S domestic
saving, they imply increased financing from the rest of the world. Increased
lending to the U.S. from the rest of the world implies a widening U.S. trade
deficit. President Trump appears to have viewed the persistent U.S. trade
deficit a result of “unfair” trade practices on the part of some U.S. trading
partners. (I presented a counter argument to this view in my November 17, 2017
commentary entitled
“At
Least We Can Be Thankful to the ‘11’ Fair Traders”.) The Trump
administration has imposed import tariffs on solar panels and washing machines
recently and has announced its intention to impose import tariffs on steel and
aluminum because of perceived unfair trade practices on the part of trading
partners. If past is prologue, a widening in U.S. trade deficits resulting from
widening U.S. federal budget deficits in the next couple of years could trigger
more protectionist actions by the Trump administration.
Let’s look at some data to build a case that U.S. federal
budget deficits are related to U.S. trade deficits. Plotted in Chart 1 are
annual observations of U.S. net
exports of goods and services from 1970 through 2017. Net exports are exports
minus imports. So, if net exports are negative, it means that the value of
goods and services imported by a country are is greater than the value of its
exports. If net exports are negative, it means that a country is running a
trade deficit. The data in Chart 1 show that the U.S. has consistently been
running trade deficits from 1976 through 2017.
Chart 1
When a country runs a trade deficit, it means that the
residents of that country are spending more on goods and services than they are
producing. To see this, let’s look at the identity for GDP:
(1)
GDP = Goods & Services Spending + (Exports –
Imports)
GDP is the value of goods and services produced in an economy. Goods and Services
Spending is the aggregate spending by households, businesses and government
entities. Imports enter the GDP identity with a negative
sign in order to avoid double counting. That is, imports account for some of
the Goods & Services Spending.
Because GDP represents the value of goods and services produced in an economy, imports need to
be subtracted from Goods & Services Spending. Because exports are not part
of domestic Goods & Services Spending but are produced in the economy, exports are added to Goods &
Services Spending.
By rearranging the terms in identity (1), we get:
(2)
GDP – Goods & Services Spending = (Exports –
Imports)
If the term (Exports – Imports) is negative, that is, a
country is running a trade deficit (net exports
are negative), then GDP minus Goods & Services Spending also must be
negative. So, a country that is running
a trade deficit, by definition, is spending more on goods and services than it
is producing. The only way a country can spend more on goods and services than
it produces is to receive goods and services from other countries. Unless the
residents of those countries providing goods and services to the country
running a trade deficit are gifting those goods and services, the residents of
the trade-deficit- running country are either incurring debt or are selling off
assets to the residents of the country providing the goods and services. In sum, a country running a trade deficit
is, in effect, a net borrower from the rest of the world.
Plotted in Chart 2 are annual observations of U.S. net
exports, the same as in Chart 1. But also plotted are the annual observations
of net financial lending or borrowing by the combined U.S. nonfinancial sectors
– households, nonfinancial business and government entities. The positive
correlation between these two series for the period 1970 through 2016 is 0.81
(looks like 0.61 in Chart 2, but is 0.81). Recall, if the correlation were
“perfect”, its value would be 1.00. So, the data in Chart 2 are supportive of
the notion that as a country runs a wider trade deficit, its net financial
borrowing increases, too.
Chart 2
Chart 3 shows from whom most of the borrowing comes when
the U.S. runs a trade deficit – the rest of the world, obviously. The negative correlation between U.S.
nonfinancial sector net borrowing and the rest of the world’s net lending to
the U.S. is minus 0.78 for the years 1970 through 2016.
Chart 3
Okay, what does all this have to do with widening U.S.
federal government budget deficits resulting in wider U.S. trade deficits? The
data in Chart 4 have a bearing on this question. Plotted in Chart 4 are annual
observations of net lending/net borrowing of the entire U.S. nonfinancial
sector, including the federal government sector, and the net lending/net
borrowing of the federal government sector by itself. The correlation between
these two series is a positive 0.64. This suggests that the federal government
budget deficit plays an important role as to whether the entire nonfinancial
sector is in a net lending or net borrowing position. And again, if the entire
nonfinancial sector is in a net borrowing position, there is a high probability
that the U.S will be running a trade deficit, with the magnitude of the trade
deficit positively correlated with the magnitude of the net borrowing position
of the nonfinancial sector, as shown in Chart 2.
Chart 4
So, we have established that the magnitude of the U.S.
trade deficit is highly correlated with the magnitude of the U.S. nonfinancial
sector net borrowing position. The magnitude of the U.S. nonfinancial sector
borrowing position is correlated with the magnitude of the U.S. federal
government budget deficit. Nonpartisan analysts are projecting higher federal
government budget deficits in the next two years. Thus, there is a high
probability that the magnitude of the U.S. nonfinancial sector net borrowing
position will increase in the next two years and with it, an increased
magnitude in the U.S. trade deficit.
There is a possibility that the likely widening in the
federal budget deficit would not result in a widening U.S. trade deficit. That
possibility rests on whether the nonfinancial sector, excluding the federal government, increases its net lending to the federal government to
prevent the total nonfinancial
sector, including the federal
government, from slipping further into a net
borrowing position. This is unlikely to happen if the federal budget
deficit reaches $1 trillion+ in FY
2019. That would be a $335+ increase in budget deficit vs. FY 2017. In the
three quarters ended Q3:2017, net lending by the nonfinancial sector excluding the federal government
amounted to $415 billion. So, net lending by the nonfinancial sector excluding the federal government would
have to increase by about 80% to prevent total
nonfinancial sector net borrowing
from widening and, thus, the U.S. trade deficit from widening. Possible, but
not probable.
At the outset of this commentary, I noted that President
Trump interprets the persistence of U.S. trade deficits as evidence of “unfair”
trade practices on the part of some of our trading partners. If the federal
government budget deficit widens as credible analysts project, there is a high
probability that the U.S. trade deficit also will widen. This could prompt the
Trump administration to adopt even more protectionist trade measures given its
view of the cause of trade deficits.
Paul L. Kasriel
Founder, Econtrarian, LLC
Senior Economic and Investment Advisor
“For most of human
history, it made good adaptive sense to be fearful and emphasize the negative;
any mistake could be fatal”, Joost Swarte
∆ + 6 = A Good
Life
