Reducing the deficit in external payments is a key objective of the Trump administration. The shortfall means that U.S. residents are consuming more products and services produced abroad than foreign consumers do in the U.S. If this could be reversed, Donald Trump’s advisers reason, it would mean that more of the globally consumed items would have been made in the U.S. with American labor.
Since the Trump election victory was predicated on improving the lot of domestic workers, this has a lot of political appeal. But his proposals mean there would be no winners in financial markets. Is there a way the Trump administration can achieve its campaign promise and have a positive impact on equity and bond markets at the same time? A history of U.S. trade negotiations over the past two decades, and a closer examination of the U.S. external payments deficit, suggest that there is such a path.
Peter Navarro, Director of the White House National Trade Council, uses the Keynesian income/expenditure identity to justify restrictions on trade. Gross domestic product is the sum of consumption, investment, government spending and net exports. It is that final item that authorities are focused on. By limiting imports through new tariffs, net exports would rise, and GDP would be higher as well. In addition to positive implications for employment, reduced competition from imports would mean higher revenues for U.S. companies, pushing up equity valuations. (Commerce Secretary Wilbur Ross said Trump will order a comprehensive study to identify every form of “trade abuse” that contributes to U.S. deficits with foreign countries.)
The solution is not so clear-cut. Investors rightly fear that administrative measures to reduce U.S. imports would not be the end of the story. As I noted in a recent column, new U.S. trade restrictions would likely be met by retaliatory measures by trading partners. Copycat higher tariffs could limit, for example, the market for Apple computers in Germany, or sales of Boeing aircraft to China.
In short, the free flow of goods and services helps sustain U.S. economic growth, create jobs in the export sector, and validate higher market valuations. Still, Trump and his advisers may have a valid point in arguing that the U.S. is not on a level playing field in dealing with trade partners. The U.S. is more open in trade than many other countries, and countries with significant surpluses in the current account of the balance of payments – – the sum of the trade balance, net interest and dividend income plus transfers – – are able to use the excess to purchase not only U.S. Treasuries but also ownership in U.S. companies.
Responding to this situation by raising trade barriers and reducing imports would limit choices for U.S. consumers, and cause overall domestic prices to increase faster. Eventually, these developments would be market unfriendly. The prospect of faster inflation would force the Federal Reserve to speed up rate hikes – – a negative for equity markets. Bond yields would increase in response to rising inflation expectations, and higher mortgage rates would hurt housing that has been a mainstay of the post-crisis economic recovery.
Successive U.S. administrations have equated a level playing field in the international economic arena to the maintenance of “proper” exchange rates. For example, since the Clinton administration in 1994, certifying whether China is, or is not, a “currency manipulator” has become an annual exercise and the focus of U.S. authorities’ negotiations.
A more productive approach would have been to shift the emphasis to obtaining greater access to countries’ domestic markets. Japanese Prime Minister Shinzo Abe’s reform measures have yet to allow increased competition in domestic sectors that was supposed to be the “third arrow” of Abenomics. Rather than worry about the yen-dollar exchange rate, the Trump administration would do well to push Japanese authorities to open up the moribund agricultural sector to increased competition from U.S. farm products. Similarly, rather than worry about the pace of appreciation of the yuan exchange rate, it would be more productive to ensure that Caterpillar or Bechtel has a fair chance of winning a contract in China.
Successful bids by U.S. companies for higher foreign market share and contracts abroad will reduce the current account deficit markedly. Net investment income from abroad in 2016 of $192 billion helped the U.S. lower the shortfall from a deficit in merchandise trade of $734 billion to a $481 billion deficit in the current account. While the net investment income from abroad has risen 45 percent from its 2009 low (see chart), it has the potential to increase further if the Trump administration makes a pronounced push for foreign market opening.
Most important, such an approach could be a win-win-win: help the Trump administration achieve its campaign promise, enable increased wages and employment for labor, and hold the promise of higher equity prices and reduced volatility for investors.
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