Why the US trade deficit is a 'made in America' problem that won't be helped by Trump's strong-arming on trade

Key Points
  • President Donald Trump has said his tariff strategy is working, and at one point suggested they could eventually help pay down the federal deficit.
  • Economists, however, beg to differ, with imports still on the rise and no end in sight to the growing federal deficit.
A US cargo ship seen at the Yangshan Deep-Water Port, an automated cargo wharf, in Shanghai on Apr. 9, 2018.
Johannes Eisele | AFP | Getty Images

The U.S. is locked in a multifront battle with virtually every major trading partner, in an effort to extract concessions that it expects to help cure the "twin deficits" that have bedeviled the world's largest economy for decades.

On Friday, negotiations on a new North American Free Trade Agreement hit an inflection point. Talks between the U.S. and Canada reached an impasse, with talks set to continue next week. Yet President Donald Trump has made clear he plans to strike a new deal within 90 days — with or without the U.S.'s Canadian partner.

Percolating in the background is the growing likelihood that the U.S. will impose an additional $200 billion worth of tariffs on China as early as next week, Bloomberg reported on Thursday.

It all raises the question of what Trump's endgame could look like, if the mere threat of a global trade war becomes an actuality. Economists and investors have been sweating over the consequences for the world economy if the U.S. can't reach a consensus with major economies like Europe, Canada and particularly China.

According to some economists, at the heart of Trump's thinking about the trade war lie two key assumptions: That the world's largest economy can narrow both its burgeoning deficit by renegotiating commercial ties with its major trading partners, and that tariffs can help accomplish these goals — by at least forcing countries to the bargaining table.

In early August the president hinted as much himself ,when he declared that his menu of tariffs were working "big time." He raised a few eyebrows when he claimed that tariffs could somehow pay down the federal debt, which currently stands at more than $21 trillion.

Trump tweet

According to some economists, Trump's declaration harked back to an era when the federal government's main source of tax revenue was derived from tariffs. According to economic historian Brian Domitrovic, that status quo prevailed until the early 20th century, but declined as the U.S. economy developed into the world's most advanced.

The president's argument got a modest boost from Congressional Research Service data, which showed that the U.S. reaped more than a billion in new revenue from steel and aluminum tariffs.

However, economists like David Wessel, director of the Hutchins Center on Fiscal and Monetary Policy at Brookings Institution, think it's "not plausible" that the U.S. will collect enough money to pay down the debt — especially with the federal government spending with no end in sight.

"The president seems to be in love with the budget we had 100 years ago," Wessel told CNBC in a recent interview. "Once upon a time the federal government got most of its revenue through tariffs, but at the time, the federal government was much smaller [and] there wasn't Social Security, Medicare, Homeland Security" and other big-ticket spending items that cost trillions, he added.

"It's hard to believe we're going to get a lot of revenue out of this, and there's no way we get enough to start paying down the debt," Wessel said.

A 'made in America' problem

President Donald Trump holds up a 'Make Our Farmers Great Again' hat as he speaks during the 2018 Made in America Product Showcase event July 23, 2018 in the Cross Hall of the White House in Washington, DC. 
Alex Wong | Getty Images

Both deficits are being exacerbated by the dynamics of the tax bill, which is widely perceived as helping to stimulate the economy.

On one hand, the stimulus feeds domestic demand — leading consumers to purchase more both at home and from abroad. However, it also deprives the government of revenues, and ratchets up deficit spending that at some point may trigger an economic crisis.

Steve Hanke, a professor of applied economics at Johns Hopkins University and a former member of Ronald Reagan's economic team, described the deficit problem to CNBC as one that's "made in America."

No matter what happens, the trade deficit is going to get bigger, [and] Trump will have egg on his face. He's doing the one thing that will expand it — he has blessed a larger fiscal deficit.
Steve Hanke

Trump's signature tax cut passed earlier this year, combined with Congress approving a massive spending bill, is expected to send the federal deficit above $1 trillion next year and beyond.

"The current fiscal policies are loosened with more government spending and fewer taxes coming in," Hanke explained in a recent interview.

Meanwhile, U.S. consumers still appear inclined to snap up foreign goods: The international trade deficit rose to $72.2 billion in July, with imports nearly double U.S. exports, Census Bureau data showed this week.

"No matter what happens, the trade deficit is going to get bigger," Hanke told CNBC, adding that Trump will "have egg on his face" when it does. "He's doing the one thing that will expand it — he has blessed a larger fiscal deficit," Hanke said.

Complicating matters is the battle between the U.S. and China, the world's two largest economies. Both sides are hardening their positions amid a nearly $400 billion bilateral trading deficit.

Trump's push for "fair trade" seeks to ensure the dominance of U.S. made products, using tariffs to make foreign goods more expensive. Yet Hanke theorized that Americans will just substitute them with cheaper goods — most of them manufactured ade in other low-cost international havens.

"Even if [Chinese imports] go down, all kinds of other countries will go up," he said. And if Trump expects China to back down, he could be in for a rude awakening, Hanke added.

"The trade war will get worse because China is not going to get rolled by the U.S.," he said.