- There is still confusion about exactly how Mr Trump’s trade war will play out
- But the US current account deficit is more likely to widen than to narrow
- If it did narrow, that would be due to very bad news on the growth front
The last week has seen what may be the triumph of US economic nationalism and the start of a trade war. “May be”, because as with almost everything coming out of the Trump White House, confusion reigns. For instance, having originally been told that the steel and aluminium tariffs would be levied on all imports, we are then told that US allies, notably Mexico and Canada at least as long as the NAFTA renegotiations continue, might be exempt. (This has since been confirmed.) We are also told that Mr Trump is musing about the US rejoining the Trans-Pacific Partnership, which doesn’t fit in with his view that trade wars are good and easy to win, but which in any case is presumably a long-term issue.
Leaving aside, for the moment, the issue of free trade as a good in itself, a perhaps more immediately relevant point is this: a rapidly disappearing US current account deficit would be bad news, for the US economy as well as for the world.
This is because the current account balance – the widest measure of foreign trade – is the balance between savings and investment by the three domestic sectors, public, corporate and household. Crucially, the sum of the four sectoral financial balances, as well as any changes in them, must by definition sum to zero.
Therefore, in order for the US current account deficit to narrow, either the domestic sectors have to invest less, or they have to save more. Either development would mean weaker activity. This is not to say that you cannot have strong growth with a current account surplus; of course you can, as is amply proven by, e.g., China. But it’s the route from deficit to surplus that is contractionary. In Q3 2017, the current account deficit was 2.1% of GDP. To eliminate this, the reduced spending or increased saving (two sides of the same coin), would, if it took place over one year, be enough to wipe out most of US growth. Over a longer period, it would sharply reduce it.
How could this take place? Looking at the outlook for the domestic sectors, the US public sector deficit has been around or just short of 5% of GDP since early 2013. The Trump fiscal stimulus package is forecast to substantially widen this. All else being equal, this will therefore widen the US current account deficit.
The household sector has been in deficit since Q3 2016, primarily because household savings have fallen relative to GDP, whereas housing investment has remained flat. However, the housing market has recently weakened somewhat, which could imply that the household sector deficit may narrow slightly. However, this may be offset by higher prices due to imported goods becoming more expensive as a consequence of tariffs.
Finally, the corporate sector has a massive surplus (just under 4% of GDP in Q3 2017). Historically, this is highly unusual (the average since the late 1950s is a surplus of 1.6% of GDP), with periods of a widening corporate sector surplus usually followed rapidly followed by reversals. These tend to come about thanks to increased investment, rather than through lower corporate savings, although since the latter are still elevated by historic standards, these may also come to play a role.
While it is difficult to estimate exactly how each sector will move, the near-term (over, say, the next four to six quarters) is therefore that two of the three domestic US sectors, public and corporate, instead of saving more and spending less, will actually save less and/or spend more. The third, the household sector, may possibly spend less and/or save more, but not enough to off-set the shifts in the other two sectors. Overall, the impact on the current account balance is more likely to be towards a wider deficit than the opposite.
In itself, that doesn’t matter. But what does matter is first, the perception of failure when the current account deficit doesn’t narrow, which could work to drive Mr Trump to further protectionism; and, second, that the domestic impact will nevertheless be a redistribution away from households to businesses and within the corporate sector from users of steel (etc) to producers. Mr Trump may still, as is his wont, claim victory. But it won’t feel that way.