Trade Deficits Caused by Budget Deficits » The American Spectator | USA News and PoliticsThe American Spectator

America is in the midst of a divisive argument regarding Donald Trump’s use of tariffs to reduce our trade deficit with other countries — the controversy began when the president first mentioned his intent to employ them. Specifically, the discourse focuses on whether tariffs are beneficial in managing trade imbalances.

Many on social media argue that protectionist advocates err in believing that tariffs increase GDP by impeding imports. While it’s true that imports are subtracted from GDP, this reduction is merely an accounting adjustment to avoid redundant overcounting. GDP accounts for domestic production only — yet, some government spending, investment, and consumption expenditures are spent on goods and services produced overseas. Taxing imports with tariffs will not predispose to increased GDP.

This misunderstanding of government accounting, however, is not the real issue of concern regarding the U.S. trade deficit. The latter is symptomatic of more fundamental structural issues in the U.S. economy. And these issues are not easily remedied by tariffs; thus, they deserve our serious attention. While trade deficits can be a problem — the real issue is the underlying reason for trade deficits.

Trade Deficits are Linked to Debt

A trade deficit occurs when a country imports more goods and services than it exports, essentially spending more than it earns. From the vantage point of national accounting, the U.S. is spending beyond its income (revenue from taxes). The shortfall between income and spending must be addressed. America fills the gap by going into debt — we borrow by selling U.S. Treasury securities.

Depending upon a nation’s economic circumstances, borrowing can be productive. There have been times in the history of the United States when borrowing has led to significant economic growth. Today, the circumstances surrounding U.S. borrowing is less encouraging. When debt is used for consumption — it becomes problematic. What is financed does not guarantee a future return — the debt incurred must be repaid through other sources of revenue. This is where the U.S. gets into trouble.

The trade deficit is essentially the other side of the financial account surplus ledger. This means that foreign capital is flowing into the United States, largely in the form of investments in U.S. Treasury bonds and other financial assets. These funds are used to finance federal government spending, which usually exceeds revenue, leading to sustained budget deficits. The trade deficit and the budget deficit are, therefore, linked.

The nature of these two deficits is such that the U.S. government borrows not to invest in future growth but, in large measure, to fund current consumption (i.e. expenditures) tied to federal spending. This is fiscally an “unhealthy” type of borrowing, like financing a vacation — it creates instability and makes the U.S. economy vulnerable to the vicissitudes of global economics.

What Doesn’t Work

Congress often reaches for simple, ostensibly “obvious” solutions — like tariffs. The reasoning goes like this: if the country has a hefty trade deficit, simply make imports more expensive and reduce the volume. Unfortunately, this fiscal response overlooks a bigger problem.

Most economists believe that tariffs are not an efficient or even an effective means of reducing trade deficits. During the first Trump administration (much like today), tariffs were placed on a wide range of imported goods — the goal was to reduce the trade imbalance. Yet, instead of shrinking, the trade deficit increased. This was partly due to the underlying macroeconomic environment; this comprised a significant increase in government spending and corresponding budget deficits. Tariffs may have reduced some imports, but they did nothing to address the broader economic forces fueling the trade deficits.

Trade deficits are ensconced in broader economic issues — especially fiscal policy. As long as the U.S. runs large budget deficits, financed partly by foreign capital flows, the trade deficit is unlikely to diminish measurably.

What Works

If tariffs by themselves won’t get the job done, how can America shrink its trade deficit? The answer lies in dealing with their root cause: government overspending. By reducing the budget deficit, the need for foreign capital inflows would diminish — the trade deficit would likely follow. However, cutting government spending (e.g. DOGE) is easier said than done, especially when both political parties have shown a proclivity towards fiscal stimulation (expansion). And nobody is suggesting cuts to Medicaid, Medicare and Social Security, which make up half the budget.

Another solution is to alter how foreign capital is utilized. Today, the foreign capital coming into the U.S. ends up in Treasury bonds, effectively financing government expenditures. The U.S. could, alternatively, navigate this capital into income-producing investments. The U.S. could establish a sovereign wealth fund which would invest capital in assets overseas, similar to the approach taken by some Gulf oil-producing states or China and Norway. This would predispose to foreign capital inflows being employed to generate future income — rather than essentially spending it on current consumption — expenditures. President Trump recently proposed a national wealth fund for the U.S.

The discourse over trade deficits and tariffs is often framed in simplistic terms: either trade deficits are innocuous, or they are injurious and must be addressed with protectionist measures. The reality, of course, is not that simple. America needs to recognize the larger macroeconomic imbalances that come into play.

What is needed is a more subtle understanding of the current U.S. trade deficit — one that recognizes it as a symptom of more fundamental fiscal imbalances rather than a problem that can be solved through trade policy alone. Addressing the trade deficit will require a combination of efforts: addressing the budget deficit, reducing excessive consumption and creating ways to steer foreign capital into productive investments. Short of this realization, we are likely to repeat the errors of history — attempting to solve trade imbalances without removing the root of their causation.

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