Misconceptions about international trade

The evidence suggests not, at least when it comes to developed countries. Hence, it can be argued that the US administration is running with the wrong policies if it wants to strengthen the economy, while Germany could easily lift its economy as its trade surplus shrinks.

The average German current account balance since 1980 has been in surplus to the tune of 3.5% of GDP. In contrast, the US has run with an average deficit of 2.6% of GDP over the same period. But in spite of the US’s weak trade position, average GDP growth has been just over 2.5% through the period; a full percentage point above Germany’s.

In short, the US has had worse trade performance but better economic growth. And it is not just the US and Germany that perform in this way. If we look right across developed countries, we see a negative correlation between trade performance and growth. There seems no support for the rationale of the Trump administration that you need strong trade to make a strong country. Why is this?

To answer, we have to come back to the fundamentals of what causes trade to be in surplus or deficit. For while some like Trump see this as a function of a country’s competitiveness, perhaps influenced by things like tariff rates and exchange rates, the truth is that these things matter very little. Instead, trade balances are created by a country’s ability and desire to live beyond its means.

What we mean by this is that deficit countries essentially choose to overspend, with the deficiency in savings made up by capital inflows from abroad. The US is fortunate in that it can continually rake in foreign savings in this way seemingly without the risk of a run on its currency and bond market. Others, especially in the developing world are not so fortunate and hence here large trade deficits can mean weaker growth if the cost of these deficits is excessive vulnerability in the currency and excessively high interest rates.

Other developed countries do not generally face such constraints. As a result, their decision to run large trade surpluses stems not from a fear of currency and bond market weakness but, instead an innate desire to maintain high savings levels. In some countries the preference for high savings lies within the private sector, like China and Japan.

In others, like Germany, it is the public sector that holds a strong preference for sound finances. But this is changing, at least in Germany’s case as the new government pushes through substantial fiscal largesse via an infrastructure fund of EUR500bn and a big tweak to the debt brake (which limits the structural budget deficit to just 0.35% of GDP) to allow for much higher defence spending. The corollary of this fiscal expansion is that it is almost certain to result in a deterioration in the trade surplus as the country sucks in foreign capital to fund these big increases in spending.

Indeed, we are already seeing how anticipation of these inflows – and possibly stronger German economic growth ahead – is pulling in capital as the stock market and euro surge. Only time will tell whether this fiscal expansion is put to good use in terms of generating stronger growth and so helping to maintain the current rise in the euro.

While all this is going on, the US will presumably be raising tariffs to try to lift its trade performance and hence growth rate. But here too we are currently seeing just how counterproductive this policy is. The trade deficit has surged, growth has sslowed, and the US dollar has slumped. Of course, this may change in time. Indeed, by the Standard Bank’s calculation, tariffs won’t improve trade and the persistence of a large deficit will mean continued US overspending and possible growth outperformance relative to Germany and other developed countries.

But that’s for the long haul. For now, the market senses that the growth gap is closing as US exceptionalism gives way to a period in which the US becomes largely unexceptional and that should allow the euro to climb to the 1.20 level against the US dollar given time.