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Tax Reform and Trump’s Chinese Trade Deficit Conundrum

by MN Gordon

Economic Prism

Trade Deficit with China Widens on Trump’s Watch

Most things come easier said than done.  Take President Trump’s posture on trade with China…

Trump doesn’t want a bigger trade deficit with China.  He wants a smaller trade deficit with China.  In fact, reducing the trade deficit with China is one of Trump’s promises to Make America Great Again.  In May 2016, he even told a campaign crowd:

“We can’t continue to allow China to rape our country and that’s what they’re doing.  It’s the greatest theft in the history of the world.”

Yet as Trump approaches the conclusion of his first year in office, he’s achieved the exact opposite of what he said.  The trade deficit with China hasn’t gotten smaller.  It has gotten bigger.  Actually, it has gotten a lot bigger.

For example, the U.S. trade deficit with China from January through November 2017 was approximately $342 billion.  Over this same period in 2016, the trade deficit with China was $317.4 billion.  This amounts to a 7.7 percent widening of the U.S. trade deficit with China that has occurred on Trump’s watch.

What gives?  Is China better at manipulating its currency than the U.S.?  Does China somehow outplay the U.S. when it comes to both trade strategy and strategery?

Certainly, The Donald will get to the bottom of it…

Unintended Consequences

Earlier this week President Trump called up Chinese President Xi Jinping to have a frank phone conversation on the matter.  From what we gather, Trump “expressed disappointment that the United States’ trade deficit has continued to grow.”

We don’t know what Jinping said in response.  But what he could’ve said was, “Donald, you ain’t seen nothin’ yet!”

One of the unintended consequences of increasing the budget deficit to pay for the GOP tax reform bill is that it also increases the trade deficit.  In other words, the budget imbalance between taxes and government expenditures has a direct impact on foreign trade imbalances.  In an article published in Asia & the Pacific Policy Studies, economist Ralph W. Huenemann explains:

“In 2016, the American government budgets carried a fiscal deficit of $865 billion, and the balance of payments showed a trade deficit of $521 billion.  A surplus of private savings (including substantial retained corporate profits) of about $344 billion over investment partially offset the budget deficit, but as long as there is such a massive deficit on government budgets, the net inflow of imports will continue.  This is inherent in the nature of national income.  No President, Donald Trump or any other, can change this reality without tackling the government budget deficit.”

So if Trump doesn’t want a trade deficit with China then he needs to reduce the government’s budget deficit.  However, reducing the government’s budget deficit is near impossible under the new GOP tax reform bill.  Hence, President Trump is left with a weak hand of bluster.

Tax Reform and Trump’s Chinese Trade Deficit Conundrum

This week Reuters released parts of its exclusive interview with President Trump.  On the prospect of a trade war with China, Trump remarked that he hopes a trade war won’t ensue, “But if there is, there is.”

Trump also commented that any change in China’s purchases of U.S. Treasuries would not hurt the U.S. economy.  This is because, according to Trump, “everybody wants to buy Treasuries.”

Let’s hope Trump knows what he’s talking about.  At the moment, China and Japan account for one-third of all foreign-held Treasuries.  However, China has currently tapered back its Treasury holdings to a four month low.  And Japan has reduced its Treasury holdings to a four year low.

But maybe Trump’s right.  Maybe China and Japan don’t matter.  Maybe someone else – like the Swiss National Bank – will pick up the slack that’s needed to finance Trump’s deficit.

Still, what would this get him?  It wouldn’t address his trade deficit conundrum; rather, it would make it worse.

The point is attempting to spend a nation to prosperity using borrowed money is not without consequences.  In the short run, an illusion of wealth can be erected.  In the long run, the illusion slips into decay and disrepair at the precise moment the bill comes due.

This is one of the tradeoffs of deficit spending based government stimulus that politicians fail to mention when promising free lunches.  Any economic boost that deficit financed tax reform delivers will be short-lived.

Quite frankly, such a contrived economic boost is akin to burning one’s furniture to stay warm.  The heat it produces feels good while it lasts.  But once the furniture’s all burned up, it’s game over.

[MN Gordon is Editorial Director and Publisher of the Economic Prism – an E-Newsletter that tries to bring clarity to the muddy waters of economic policy and discusses interesting investment opportunities.]

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