Let's stop the trade deficit blame game

Everyone with a command of basic arithmetic agrees that the US current account trade balance—the broadest measure of its trade deficit—equals US saving minus investment. That’s where agreement stops.

Many economists suggest that low US saving, partly due to a federal budget deficit that reached a whopping 6.4 percent of GDP in 2024, could plausibly play a role in causing America’s large and persistent trade deficit. Proponents of tariffs or other trade-limiting measures push back furiously. The United States is a blameless victim, they say. US trade deficits arise from other countries’ mercantilist policies, foisted on a US economy that previous leaders have fecklessly and recklessly left open to external actors. To restore balanced trade, they argue, it is time to take back control.

Anyone who points out that the United States borrows abroad because its saving falls short of its investment faces the retort that foreign saving exceeds investment by the same amount (another consequence of arithmetic). But neither observation suffices to determine the origin of the pattern of global imbalances, because saving and investment rates have deeper fundamental drivers. It is only those that can justifiably be labeled as “causes” of the US deficit.

Those potential causes are numerous: Some surely do originate abroad, but some are purely domestic. In a world of interconnected markets for trade and capital, events in one place—whether government policies, natural disasters, or human-made shocks—have repercussions abroad. In a global equilibrium, the supply of foreign funds to the United States and the US demand for those funds must be equal: The US deficit can rise because of higher supply, higher demand, or changes in both.

Chinese policies that suppress domestic consumption and promote saving beyond the country’s investment certainly propagate through world markets and induce bigger current account deficits abroad. They can push down global interest rates, push up asset prices overseas, and lead foreign currencies to appreciate.

But US factors matter too. For example, the US personal saving rate has fallen from levels usually above 10 percent during 1960–80 to an average below 5 percent in post-pandemic data. Persistent federal budget deficits are another cause of the low national saving rate. Because US investment has not trended downward, a sizable and stubborn current account deficit has emerged.

Figure 1 shows the US national saving and domestic investment rates (as a percentage of GDP) in comparison with other big players in global capital markets.[1] Countries like the United States located above the 45 degree line (where investment exceeds saving) have current account deficits; countries below the line have surpluses.

Total saving in the United States is exceptionally low by international standards. If the mercantilist promotion of saving abroad were the chief cause of low US saving and the US trade deficit, we would expect to see many other advanced economies having comparably low saving rates. Figure 1 shows that this is not the case.

Some analysts claim that the high saving of countries like China “forces” the United States to have a low saving rate. Apart from asset price effects that encourage US households to spend, these analysts maintain that US fiscal deficits are a response to foreign inflows that would otherwise cause unemployment. This story contradicts the facts. In 2000 under President Bill Clinton, for example, the United States achieved a federal budget surplus and an unemployment rate of around 4 percent despite a trade deficit that was 3.7 percent of GDP—higher than the 3.1 percent of GDP deficit in 2024.

A US fiscal correction would lead to a dollar depreciation and a smaller trade deficit; any remaining negative effect on employment could be offset if the Federal Reserve cut interest rates. The United States is not without agency. Outside of recessions, intransigent US fiscal deficits mostly reflect fiscal dysfunction rather than a purposeful plan to support the economy.

Despite China’s being the most prominent practitioner by far of export subsidization, its surplus doesn’t come close to matching the US deficit. As figure 2 shows, China’s surplus was only 34 percent of the US deficit in 2023. The surpluses of advanced countries outside of Asia, all of them quite open, were approximately equal to the US deficit in that year. This doesn’t necessarily mean that the US deficit was primarily “caused” by advanced-economy surpluses, any more than it was primarily “caused” by China’s surplus.

Some analysts go further. They contend that because of its open capital markets, the United States is the overwhelmingly favorite target for capital inflows from persistent surplus countries like China. For example, Michael Pettis at the Carnegie Endowment for International Peace has written:

Countries that run large, persistent trade surpluses must acquire foreign assets to balance these surpluses. American assets are particularly attractive for this purpose, and the United States allows nearly unfettered access to these assets. As a result, surplus countries prefer to acquire assets in the United States in exchange for their surpluses, which also means that the United States must run the corresponding trade deficits.

Contrary to Pettis’s assertion, countries can acquire US assets without the United States running a current account deficit simply by paying for assets located in the United States with non-US assets rather than with their exports.

Aside from that conceptual flaw, however, there is an empirical challenge. If it is accurate that countries have a strong preference for claims on America, then we would expect other countries to invest most of their external assets in the United States. This is nowhere close to true. Figure 3 shows the share of the rest of the world’s foreign assets invested in the United States.[2] That share hovered around 19 percent for the first part of this century before rising to nearly 25 percent starting around 2014, as the dollar appreciated (raising the relative value of claims on the United States) and the US stock market outperformed. Broadly speaking, these shares track the US share in global GDP, which in 2023 was 25.8 percent.[3]

Whatever the cause of the US trade deficit, economists believe that setting tariffs in the range President Donald Trump has floated will not affect it decisively. Tariffs could have some effect on saving and investment, but it is unlikely that they would greatly change the saving-investment balance or push it in one direction or the other.

Three recent macroeconomic developments could reduce the US deficit. One is the European realization that more defense spending is imperative, exemplified by incoming Chancellor Friedrich Merz's efforts to relax Germany’s stringent fiscal rules. A second is China’s announcement of enhanced fiscal stimulus in response to US tariffs and domestic economic difficulties. A third would be a US recession, brought on primarily by the unprecedented economic uncertainty from erratic implementation of tariff policies, mass deportations, and large-scale layoffs and contract cancellations by the Trump administration. A recession would likely raise saving by compressing consumption, and it would surely depress investment—but even if a lower trade balance is a worthy goal, this is not the method of trade-balance reduction that anyone wants to see.

Notes

1. The data in the figure are for 2023. The IMF will not release the 2024 data until late next month.

2. Let \( A_i \) denote the gross foreign assets of country \( i \) and \( L_i \) that country’s gross foreign liabilities. If all countries wish to invest the same share of their gross foreign assets \( \alpha \) in the United States, then \( \alpha \) can be measured as the number reported in figure 3, which is:

\[ \alpha = L_{US} \big/ \sum_{i \neq US} A_i \]

If each country \( i \) has a distinct preference share \( \alpha_i \) for US assets, then the global weighted average preference share for US assets is still calculated as in figure 3:

\[ \sum_{i \neq US} \alpha_i \left( \frac{A_i}{\sum_{i \neq US} A_i} \right) = L_{US} \big/ \sum_{i \neq US} A_i \]

3. The cited US GDP share is evaluated at market exchange rates, based on World Bank data. Some countries may hold foreign claims on intermediaries outside the United States, who in turn directly hold US claims or hold claims on other intermediaries who do. This practice creates an inflation of external claims on non-US counterparts, much like multiple deposit expansion within a banking system. In some cases, the goal may even be to obscure beneficial ownership. Nonetheless, the numbers illustrate that there are many places outside America where residents of current account surplus countries feel safe parking their earnings.