Commentary: The United States set a new record last month, which is the largest trade deficit excluding oil on record. And the trade deficit is likely to get larger. This is due to a phenomenon known as the twin deficit, so named because trade deficits tend to mimic government budget deficits.
Of course, any number of factors affect the trade deficit. Among these are the exchange rate, the disposable income of our selves and our trade partners, and tariffs, all things that are influx. But the government budget deficit has an important influence.
To understand the connection, it is important to remember that global financial markets are highly integrated globally. Funds saved by a resident of Las Cruces and deposited in a local bank branch will as fund a loan made to a business in France as in the United States. Similarly, savers in Europe and Asia are funding investment in Las Cruces.
In an era of rising government deficits, funding for the deficit comes not just from our citizens but are supplied globally. In fact, about half of all federal debt is held by foreigners, with China having the largest foreign holdings.
Large U.S. federal deficits sop up savings and in so doing, force private businesses to pay higher interest rates. The competition from the private sector then causes government rates to rise also. We have seen that as 10-year U.S. bonds have recently hit new post Great Recession highs.
The higher U.S. rates attract foreign savings to the United States. Much of this info is absorbed by budget deficits, but much also finds their way in to the private sector where they are used, at least in part, to purchase imported goods.
In fact, the inflow of foreign funds may be sufficient to completely offset, or at least nearly so, the budget deficit so that private investment remains nearly unchanged. In these circumstances, private U.S. investment remain nearly constant and the change in the inflow of foreign funds is identical to the change in the budget deficit.
The trade deficit must be exactly equal by the flow of foreign funds into the country. That is, if we are buying more from foreigners than we are selling to them, these purchases have to be funded somehow. Either foreigners are lending to us, for example, by buying U.S. bills and bonds, by buying physical and financial assets, or by buying official reserves from the Federal Reserve.
The fundamental problem is that the ballooning government deficit means less domestic savings. That might mean less domestic investment, but more likely, it will mean that foreigners will make up for the declining in domestic savings by lending more to the American economy. Profitable investments will still be funded, just that the funds will come from foreigners.
Here is the irony. President Trump is an avowed American nationalist yet his policy of large government deficits will result in an inflow of foreign capital into the United States. Foreigners will either buy up government debt, or else U.S. citizens will buy that debt leaving it to foreigners to fund private investment. In either case, the end result will be more control of the U.S. economy by foreigners.
Christopher A. Erickson, Ph.D., is a professor of economics at NMSU. He has studied the macroeconomic economy since the 1980s. The opinions expressed may not be shared by the regents and administration of NMSU. Chris can be reached at chrerick@nmsu.edu.