With tariffs in the news and rattling markets earlier this week, it is a good time to look at the US balance of trade and the catalysts for tariff proposals by the Trump Administration. Before delving into details, below are my principal conclusions based on the research I have done.
The US has run a balance of trade deficit since the early 1980s. President Trump clearly does not like this and believes that blanket tariffs are the solution.
The factors that cause the US to run a balance of trade deficit year after year are related to a myriad of factors, many of which are not at all related to unfair trade practices by other countries.
In cases where unfair trade practices are detrimental to the US, the policy response to use targeted tariffs to level the playing field makes sense.
As we have already seen, financial markets do not like blanket tariffs, mainly because they spawn tit-for-tat responses from other countries (rather than a change in behaviour), and this is detrimental to global economic growth.
What are the messages from the opening salvo of Trump tariffs?
Financial markets spoke loudly on Monday morning following the announcement of tariffs by President Trump on Canada, Mexico and China, with the EU apparently also in the administration’s sights. Even though Mexico and Canada were both granted temporary reprieves the same day the tariffs were announced, financial markets had enough time to signal the potential damage that tariffs could inflict on the US and global economy. Before the decision to delay tariffs on Mexico and Canada was made on Monday afternoon, markets responded early in the session exactly as might be expected:
Global stocks were lower, with the S&P 500 gapping down at the open and then drifting lower, off nearly 2% by mid-morning before staging a recovery post-recission of tariffs on Mexico and Canada. Global stocks were lower too with the Stoxx 600 (Europe) down 0.9%, the FTSE 100 (UK) down 1.0%, and Nikkei 225 (Japan) down 2.7%.
The US Dollar strengthened against the Yen and the Euro, among most other currencies.
Yields at the short end of the US Treasury curve increased, reflecting the likelihood of higher inflation and a longer Fed pause to address tariff-induced inflation. Yields at the intermediate and long end of the curve were slightly lower, balancing the effects of higher future inflation with the likelihood of slower U.S. economic growth caused by tariffs.
Gold was higher as general risk in the financial markets increased because of higher uncertainty.
As the response of global investors suggested, blanket tariffs are generally viewed as a negative for economic growth, and hence, for corporate earnings. The driver of Mr Trump’s tariff policies is the deteriorating balance of trade deficit, which is illustrated in the graph below from FRED. For reference, a balance of trade deficit means that the US is a net importer of goods and services, meaning it imports more than it exports.
Does President Trump have a point?
Mr Trump believes that trade deficits are largely attributable to an uneven playing field, meaning that through various means, foreign countries make their products and services unfairly competitive in the global marketplace. This disadvantages US companies that wish to sell their products in the global market place, since they often get undercut on prices. It is certainly true that unfair trade practices are a factor that contributes to the balance of trade deficits run by the US, but the causes are much broader and more nuanced simply because many of the contributing factors have nothing to do with trade per se but are indigenous to the US. Before getting into the reasons in more detail, let’s take a look at trade data by country and products.
Trade data using Bureau of Economic Analysis data for 2024 through the end of November
The table below from the most recent BEA release (here) illustrates the top 10 countries with which the US runs a balance of trade deficit, ranked from highest (i.e. worst) trade deficit to lowest. Perhaps not surprisingly, many of the countries – starting with China, a longstanding leader – are located in Asia where labour costs are much lower than in the US. Also raising the ire of Mr Trump is Mexico, the second country on the list. Not surprisingly, both China and Mexico were targeted by Mr Trump on Monday in his opening tariff salvo, although Mexico was given an almost immediate reprieve because it agreed to tighten its borders to clamp down on illegal immigration and the flow of drugs, specifically fentanyl.
If you focus on the middle section (“Exports”) in the table above, you will see that America’s largest export markets are not surprisingly its southern and northern neighbours – Mexico ($309 billion of exports YtD) and Canada ($322 billion of exports). Also not surprising given their proximity, Mexico is the largest importer of US goods and Canada is the third largest importer, illustrated in the right-most section (“Imports”) in the table above. While Mr Trump would like to reduce the imports from both countries into the US, the reality is that tit-for-tat tariff responses from either or both countries would simultaneously worsen US exports to both countries. In other words, all three countries would be worse off in terms of economic growth, although the consensus view seems to be that the net effect would be less harmful to the US. In reality, it is impossible to say until such a scenario were to play out. I believe though that blanket tariffs like this would undoubtedly destroy economic value, negative for global economic growth.
By region, Asia – largely characterised by cheap labour in emerging countries – is the region that accounts for the largest trade deficit for the US (42.7%), followed by European countries (21.6% of the trade deficit), justifying why the EU is in the sights of the American president.
The Bureau of Economic Analysis data also shows that goods rather than services are the major problem as far as the US trade deficit. In fact, the US runs a balance of trade surplus for services. Through the end of November 2024, the overall balance of trade deficit for the US was $814 billion, of which the trade deficit for goods was $1,083 billion and the trade surplus for services was $269 billion.
As far as products, the tables below provide largest 15 product categories of imports into and exports from the US for the period January to November 2024.
Looking at the table above, automobiles (vehicles and parts), pharmaceuticals, oil and anything tech-related are the largest general categories of US imports. These are offset partially by US exports, broken down as follows:
These tables illustrate one obvious flaw in the approach by the Trump Administration involving oil, which is the US’s largest imported product and its third largest exported product. In fact, oil and oil-related products are actually the top exports by far when combining crude oil exports (#1), other petroleum products (#3) and plastic materials (#12), all of which are refined oil derivatives. Although the US is considered energy self-sufficient (as both the largest producer and largest consumer of oil in the world), it has also built world-class facilities that are used to refine heavier oil coming from Canada and Mexico, which it can then resell internationally. In this respect, the transport and refining of oil is integrated across Canada, the US and Mexico, and any artificial economic barriers such as tariffs would make all three countries worse off. This is a prime example of the problems of blanket tariffs.
Why does the US run a perpetual balance of trade deficit, and is this harmful to the US economy?
Trade deficits in the US are caused by a myriad of factors, many of which are not related to unfair trade practices of other countries. Factors like strong economic growth, the relative strength of the US dollar, the attraction of investing in the US, and the low US savings rates are important factors. Keep in mind that the US is a consumer-driven economy, and Americans love to spend, spend, spend, which is reflected in a low savings rate compared to most other countries around the world. The consumer has been a key engine of exceptional U.S. economic growth, one of the attributes I discussed in a recent article in EMC entitled American Exceptionalism. Since Americans have a low savings rate compared to many other countries, the investment required to sustain US economic growth depends on foreign investment which is readily available. All of these factors are completely unrelated to unfair trade practices but they very much contribute to the US balance of payments deficit year after year.
Why and when are tariffs justified?
In a perfect world of fair and free trade, I do not support tariffs of any sort because they distort the allocation of resources and labour, making the world less productive and reducing global economic growth. Comparative advantage mean countries should want their companies to focus on products and sectors in which they have an advantage vis-à-vis other countries. Advantages might include for example the ready availability of educated labour or the availability of low cost labour; or access to certain natural resources like oil or minerals.
The problem is that the world does not operate in a way that reflects comparative advantages, and many countries tip the scales in the favour of their companies or industries to stimulate their own economic growth by causing exports to be higher than they otherwise would be. Also, many countries – including the US – tend to favour sectors or industries they deem critical to their own well-being, e.g. national defence. Lastly, since the pandemic, on-shoring supply chains has also become a more strategic interest of many countries.
In many of these case, it is difficult not to be sympathetic to the use of targeted tariffs to level the playing field. Foreign governments can tilt the playing field through a variety of means, such as keeping their currency artificially low (to make their exports cheaper in the global marketplace), providing subsidies to domestic companies or industries that then export subsidised products or services which would otherwise not be competitive on the world stage, or by stealing intellectual property of foreign companies. This brings one country very much to the forefront, which is China. Undoubtedly, the playing field has been tilted at the expense of the U.S. towards China for many years due to actions by the Chinese government. Therefore, I believe Mr Trump was right in trying to level the playing field via tariffs on China during his first term, a feature that carried over to the Biden Administration and now is being ratchetted up under Trump 2.0.
One unique feature of China, contributing to the country being a habitual offender, is that its currency – the Renminbi – is not convertible or free floating. Rather, China manages (or manipulates) its exchange rate vis-à-vis the US Dollar. By doing so, China can make its exports cheap in the international marketplace. No developed country follows this protocol, as their currencies freely float. Although not alone, China also provides subsidies to select industries that make US manufacturers less competitive, affecting the growth and competitiveness of domestic businesses and pushing supply chains abroad. This was a focus of Mr Trump in his first term, when he put tariffs on Chinese steel and aluminium, both industries that benefit tremendously from subsides from the Chinese government, weakening US production of both that otherwise might find a larger international market (via exports).
Levelling the playing field can be accomplished through tariffs if the offending country chooses not to rehabilitate itself by dropping unfair competitive practices. Naturally, this is best addressed country by country, and even on a company- or industry-specific basis. Blanket tariffs, especially on the US’s friends to the north or south of the border, are too broad and not sufficiently targeted to address the specific culprits. The supply chains of the US, Canada and Mexico are also very intertwined, and blanket tariffs on these countries will undoubtedly come back to haunt the US no matter how Mr Trump wants to spin his story.
Are trade deficits bad?
On the surface, running a balance of trade deficit year after year simply does not sound good. However, as I have mentioned above, many of the reasons these deficits occur are related to the fact that Americans like to spend rather than save, the US economy is extremely strong and diversified, the US Dollar remains the global reserve currency, and the US is the “go to” for attractive investment returns (so investment capital is available even though US savings alone is not sufficient) to fund strong US economic growth. Of course, in cases where the US is taken advantage of through unfair trade practices, it is hard to argue that using tariffs to level the playing field on a focused basis does not make sense. Most economists believe that a balance of trade deficit needs to be considered in the context of the exceptional US economy, and for this reason, the trade deficit should not be overly concerning. Instead of spending so much effort on the trade deficit, I believe the Trump Administration should focus much more on addressing the ever-growing national debt and increasing deficits, a much more threatening problem for the future of the US as a global economic power.
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