Ⅳ The U.S. Trade Deficitand Foreign Debt

A. U.S. Trade Deficit

1. Some explanations for large U.S. trade deficit

(1) Unfair trade

The U.S. is open to trade and thus importinga lot. Other countries are closed so that they don’t buy enough from the U.S.

(2) Twin deficit

Because our government runs budget deficit,so we would have trade deficit.

(3) Investment Demand Shift

People like to invest in the U.S. much morethan before.

2. Unfair Trade

According to this claim, to explain whathappen to the U.S. trade deficit since 1982, two things must happen:

(1) Foreign countries must have suddenlyincreased their trade protection in 1982.

(2) All countries must have decided toprotect themselves against the U.S. at the same time.

Neither of the above statements was true.

(1) In fact, many countries reduced tradeprotection and opened their economies.

(2) There was no coordinated protectionagainst the U.S.

Thus, it is unlikely that this popular claimis an explanation for the U.S. trade deficit.

3. Twin Deficit: Derive saving and investment

First, we need to go back to our basicmacroeconomics to derive the saving and investment relationship.

(1) Saving and Investment Relationship

Let Y be Gross Domestic Product (GDP)

                    Y= C + I + G + (X – M)

Y = domestic output or income

C = consumption

I = private investment

G = government spending

X = exports

M = imports

(X – M) = net exports or the trade balance

Twin Deficit
Derive saving and investment (cont.)

Y = C + I + G + (X – M)

Y – C – I – G = (X – M)

Y – T – C – I + T – G = (X – M)

(Y – T – C) – I + (T – G) = (X – M)

 Private saving = (Y – T – C) =income-after-tax minus consumption spending

Public saving = (T – G) = tax revenues minusspending

 (Y – T– C) – I + (T – G) = (X – M)

If the LHS of the equation is negative, theRHS of the equation will also be negative.

Trade deficit comes from the negative valueof the LHS of the equation

Negative RHS → (X – M) < 0 → X < M

T – G (public saving)

T > G → budget surplus

T < G → budget deficit

(Y – T – C) – I (private saving (S) minusdomestic investment)

S > I → positive net private saving

S < I → overinvestment

(2) How does trade deficit arise from government budget deficit?

If the government spending exceeds taxrevenue, then

T–G < 0 → government will have to borrow money tofinance its spending by issuing bonds (T-bills)

Interest rate in the U.S. will rise.

Suppose that ↑ ius > iJAPAN

Japanese would like to invest in the U.S.(buy T-bills), which will increase demand for the U.S. dollar.

$ will appreciate as Japanese trade ¥ for $.

U.S. exports become more expensive →↓ X

U.S. imports become cheaper →↑ M

(↓X - ↑M) ↓

Trade deficit

4. Investment Demand Shift

An increase in investment demand could come from 1980s deregulations and 1990sIT boom. These events have increased demand for investment capital and driventhe interest rate in the U.S. upward.

Interest rate in the U.S. will rise.

Suppose that ↑ ius > iJAPAN

Japanese would like to invest in the U.S.,which will increase demand for the U.S. dollar.

$ will appreciate as Japanese trade ¥ for $.

U.S. exports become more expensive →↓ X

U.S. imports become cheaper →↑ M

(↓X - ↑M) ↓

Trade deficit

B. How to eliminate the trade deficit?

If twin deficit idea is true, trade deficitis just a symptom of fiscal budget deficit. To eliminate trade deficit, we haveto eliminate the fiscal budget deficit.

If the investment demand shift idea is true,trade deficit can be eliminated by banning foreign investment or making theU.S. unappealing for investment. However, these options may not be the bestpractice for the economy in the long run. Trade deficit is a symptom offoreigners’ belief in the U.S. economy.

C. How big isthe U.S. foreign debt?

U.S. residents have over $20 trillion worthof claims on foreign assets, whereas foreigners hold $22.5 trillion in claimsof the U.S. assets.

So, we owe $2.5 trillion more than we receivefrom the rest of the world.

Is it bad?

Not necessarily.

Foreign central banks and governments areholding large amount of U.S. assets as their foreign reserves.

On the private side, our foreign investmentpays more than the returns on our assets that foreigners are holding.  We generate net investment income surplus.

So, the $2.5 trillion international debt isnot a burden to our economy so far.

Ⅴ The Balance of Payment  Equilibrium(or Disequilibrium)

A. Balance of Payments Equilibrium

Countries can have an equilibrium balance onthe current account that is positive, negative, or zero, depending on whatcircumstances are sustainable over time.

B. What happens if there is a disequilibrium in the balance of payments?

Under floating exchange rate: the exchangerate will adjust to restore the BOP equilibrium.

Under fixed exchange rate: the central bankmust finance the trade imbalance by international reserve flows (there will bereserve assets losses from deficit countries and reserve accumulation bysurplus countries).

Or, countries may use trade restrictions onimports, exports, and/or restrictions on capital flows.

Trade Deficit

来源：https://www.investopedia.com/terms/t/trade_deficit.asp

Current Account Deficit