What to Do about the Trade Deficit: Nothing

Roosevelt Institute has a new roundup of policy advice for the next administration. There is a lot of useful stuff in there, which perhaps I’ll post more on later. My own contribution is on international trade. Here’s the summary:

It is natural to look to measures to improve the trade balance — through a weaker dollar, or through tariffs or other direct limits on imports — as a way to raise demand and boost output and employment. While the U.S. has done little to boost net exports in recent decades, there is increasing public discussion of such measures today…

We argue that while the orthodox view is wrong about trade being macroeconomically neutral, measures to improve the U.S. trade balance would nonetheless be a mistake. All else equal, a more favorable trade balance will raise demand and boost employment. But all else
is not equal, thanks to the special role of the U.S. in the world economy. The global economy today operates on what is effectively a dollar standard: The U.S. dollar serves as the international currency, the way gold did under under the gold standard. In part for this reason, the U.S. can finance trade deficits indefinitely while most other countries cannot. For many of our trade partners, any reduction of net exports would imply unsustainable trade deficits. So policies intended to improve the U.S. trade balance are likely to instead lead to lower growth elsewhere, imposing large costs on the rest of the world with little or no benefits here.

We do not deny that the trade deficit has negative effects on demand and employment in the U.S., but we argue this is only a reason to redouble efforts to boost domestic demand. The solution to the contractionary effects of the trade deficit is not a costly, and probably futile, effort to move toward a trade surplus, but rather measures to boost investment in both the public and private sector.

You can read the rest of my piece here.

There were a couple figures that didn’t make it into the final piece. Here is one, showing the stability of the international role of the dollar over the past 20 years.


The dotted line shows the share of central bank reserves held in dollars (source). The heavy line shows the share of foreign-exchange transactions that involve the dollar (source). About two-thirds of foreign exchange reserves are held in dollars, and close to 90 percent of foreign-exchange transactions involve the dollar and some other currency. These shares have not diminished at all over the past 20 years, despite continuous US trade deficits.

In my opinion, the international role of the dollar makes it exceedingly unlikely that the US could face a sudden outflow of foreign investment. (And given that US liabilities are overwhelmingly dollar-denominated, it is not clear what the costs of such an outflow would be.) It also makes it highly unlikely that the US can achieve balanced trade through conventional measures, unless we come up with some other mechanism to provide the rest of the world with dollar liquidity.