The Uncertain Economic Outlook: Trade Wars and Domestic Policy
Long-Term Stability Requires Fiscal Discipline, Not Trade Barriers
This is a time of great economic uncertainty, much of it caused by a confusing and chaotic trade war—a conflict that undermines global commerce and threatens to reduce the wealth that free trade fosters among nations. This war is justified by the notion that tariffs are needed to fix the United States’ persistent trade deficits, which—according to this line of thinking—are caused by unfair foreign trade practices. However, if one looks more carefully, these deficits are due to far more than unfair trade. Especially significant is the nation’s excessive fiscal spending, borrowing, and printing of money to fund its undisciplined spending. Addressing these domestic issues would be a far more effective way to reduce trade deficits than relying on tariffs, while retaining the benefits of trade and promoting U.S. and world economic growth.
Trade: A Catalyst for Wealth, Undermined by Uncertainty
Trade, when conducted freely and fairly, is one of the most effective ways to increase wealth among nations. It allows countries to specialize in industries where they have comparative advantages, leading to more efficient production and higher standards of living. The United States exemplifies this principle. In joining disparate states, its founders understood the benefits of open markets. Our constitution forged a system of free trade among the sovereign states, assuring that goods, capital, and labor could flow freely across borders. Different sections of the country could specialize in the production of certain goods and trade them freely across the country, protected in their right to do so by the rule of law. This open exchange has fostered innovation, higher productivity, and stronger economic growth, and it has made the United States among the most successful economies in history.
When this model is applied among nations, the benefits can be every bit as great. However, implementing it is more difficult, as frictions among nations can undermine the process. Multilateral treaties are difficult to establish and often harder to enforce. Competing national commercial and strategic goals clash and are difficult to overcome. Powerful special interests plead for protection from foreign competition and succeed, undermining trust among nations. As a result, tariffs and non-tariff barriers grow, subsidies are introduced, and trade becomes a zero-sum game with winners and losers instead of a growing-sum system. To maximize the benefits of trade, these frictions must be acknowledged and dealt with to avoid such outcomes. It is difficult but doable and should remain a priority.
Nations may be justified in protecting some sectors of their economies for national security needs, but such exceptions should be used sparingly for they can be abused to benefit the few and disadvantage the many. If trade restrictions are implemented, the reasons should be made clear, and the cost in lower productivity and higher prices to businesses and consumers should be understood.
The Hidden Link: Fiscal Deficits and Trade Imbalances
Unfair trade practices may be a contributing cause of U.S. trade deficits, but they are not the real source of the problem, and imposing tariffs—taxes—on the public will do more harm than good. The more important driver of the nation’s trade deficits is its habitual fiscal deficits, its creation of excess demand, and higher inflation for both assets and goods and services—all of which can lead to higher costs for domestic goods relative to foreign goods.
The U.S. dollar is the world’s reserve currency (it has replaced the gold standard for conducting and settling international exchange). This “privilege” has enabled U.S. fiscal and monetary authorities to constantly stimulate and subsidize the nation’s demand for goods and services, to the point where the U.S. now consistently consumes more than it produces. Like all privileges, this one too should be enjoyed—but it can be problematic if overused. As a reserve currency, the U.S. can create new dollars and new debt, and it trades this debt for goods from the rest of the world. Our trading partners, in total, consume less than they produce (that is, they save) and trade their excess production (goods) for U.S. debt and other assets.
As a result of the dollar privilege, the U.S. can more easily sell its debt and use credit to buy goods from around the world. Congress can more easily run large fiscal deficits, and the Federal Reserve can more easily print the dollars to help finance those deficits. This year, for example, the federal deficit will be $2 trillion, and not by coincidence its trade deficit last year was over $1 trillion. The nation’s total debt exceeds $37 trillion, and foreign interests hold 20 percent of that debt. They also hold 20 percent of U.S. equities and 30 percent of U.S. corporate credit. The rest of the world has been very willing to provide the goods we want to consume and to invest in our great country. We have very much enjoyed our privilege. The world has done what we incented it to do. If we believe trade deficits are bad, we should be cautious about whom we blame. These trade numbers result from more causes than unfair trade practices.
Thus, if solving our trade deficit is a priority for policymakers, imposing draconian tariffs is a poor solution. Choosing to use the nation’s dollar privilege more prudently would work better.
The Outlook
The current outlook is uncertain, but there are good options for restoring confidence. The U.S. should lead the effort to end the trade war. It should negotiate transparent, mutually beneficial trade agreements, which will reduce uncertainty and allow businesses and consumers to benefit from open markets, fair competition, and reduced prices and costs.
Congress should curb excessive government spending and borrowing. This involves responsible fiscal management—reducing deficits, controlling debt, and better enabling the private sector to make strategic investments that support productivity and innovation. History shows that responsible fiscal policies will better balance budgets, accelerate economic growth, and expand consumer income and welfare, and likely narrow trade deficits.
Monetary policy also must be aligned with these goals. The Federal Reserve should avoid excessive money printing and focus on maintaining stable prices, wages, and confidence in the dollar.
Finally, to the extent they restore calm and confidence, these actions will also reduce the risk of an unwanted and unnecessary U.S. recession. Resolving trade disputes and restoring fiscal and monetary discipline will stabilize the economy, foster growth, and help the U.S. remain the world’s leading economic success story. It is simply a matter of choosing to act.