Last Updated on April 5, 2019
Last year the US’s trade deficit was at a 10 year record high, despite the current administration’s efforts to curtail it. According to the US Department of Commerce the deficit has grown to a whopping 621 billion dollars, comparable to the deficit back in the mid 2000s. Imports exceeded exports by 59.8 dollars in December of 2018. It was the highest deficit of the past year, outpacing November by 9.5 billion and analyst expectations by 3.5 billion.
One can’t accuse the President of not making every possible effort to try and rectify the issue. Reducing the trade deficit was one of the platforms he ran on and he has since then taken a number of measures to that effect. These include suspending the Transatlantic Trade and Investment Partnership (TTIP) negotiations with the European Union, renegotiating the terms of the North American Free Trade Agreement (NAFTA) with Canada and Mexico, rushing head first into a trade dispute with China, as well as revoking trade privileges from India and Turkey.
The affected countries have posited that these actions violate the World Trade Organization (WTO)’s rules and the US may need to legally defend its decisions at the international forum in the near future. China, Russia and the EU have all issues complaints against Washington for circumventing some of the very processes it helped establish itself by unilaterally altering trade conditions.
The question of tariffs has been at the forefront of this discussion. Initially it was limited to only steel and aluminum, however, it quickly expanded to include a broad range of products. The hope was to rapidly and significantly improve the USA’s trade balance, however, all the targeted countries responded by promptly enacting their own revenge tariffs. China for example, reduced its imports of certain US products to almost zero. Obviously these countermeasures diminished the effectiveness of the tariffs to some degree, yet what likely had an even more notable impact on trade balance was monetary policy.
The Fed made 2018 the year of the strengthening dollar with its policy of continued interest rate hikes. The USD gained in value against almost every major currency last year. The difference in interest rates made the dollar the number one target for carry trade. Investors keep their savings and capital in dollars, meaning they purchase the USD while selling their own respective currencies, simply because the high interest rates make speculating against the dollar a pricey proposition. The minimum yearly financing cost is 2.5% for the Euro, 2.6% for the Yen and 3.25 for the Swiss Franc. Given the powerful dollar it should come as no surprise that the trade deficit has increased. US products have lost some of their demand due to the rising tariffs. At the same time the increased purchasing power of the powerful dollar has made conditions favorable for importing foreign products.
The effects of these phenomena can also be observed in the evolution of trade balance. The latest figures suggest import has grown by 2.1% and exports have decreased by 1.9%. Given these circumstances it’s understandable that the President would try to put some pressure on Fed Chair Jerome Powell in the latter half of 2018 to slow their continuous interest rate hikes. That being said a polite appeal from the President would have little influence on the actual decisions of FOMC members in their decision making. This dichotomy between fiscal and monetary makers deserves some of our attention.
The Fed’s primary aim is to keep inflation low and the dollar’s price stable. A strong dollar is an efficient tool for meeting that goal, since it acts as a safeguard against inflation for a country with a high import ratio. One even could point to this as the underlying reason for why the tariff increases didn’t cause any significant inflation in the US.
In the end both parties did what they believed to be in the economy’s best interest, even if it resulted in them becoming two opposing forces pushing against each other. According to the macroeconomic data, The Fed’s decisions had a significantly larger impact than the tariffs. Keep in mind that this assessment is based on the present state of the market and circumstances could shift rapidly. One example would be if a China-US trade agreement resulted in tariffs being lowered while the USD remains close to today’s relatively high value. In that case the US price index could being declining sharply, potentially forcing The Fed to start lowering interest rates, thus leading to the USD’s almost immediate weakening. That’s just one case where the administration’s policy could lead The Fed to re-evaluate its original plan and instead follow suit.
