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The Fiscal Cliff and the U.S. Trade Deficit

Politics / Protectionism Nov 21, 2012 - 03:47 AM GMT

By: Ian_Fletcher


First, let’s get the definitions straight, as confusion about definitions is the single biggest avoidable cause of economic nonsense.

The trade deficit measures how much America’s imports exceed its exports.

The federal deficit measures how much America’s government’s expenditures exceed its revenues.

The cure for a trade deficit, for the U.S. or any other country, is to either export more or import less.

The cure for a central-government deficit (which is a federal deficit in other nations with federal political systems, not otherwise) is to either reduce government expenditures or bring in more taxes.

Despite enormous clouds of intellectual squid’s ink spewed about these two subjects, deliberately designed to create phony complexity and thereby enable sophistry, the above is just accounting. It isn’t even economics. So while there are an infinite number of legitimate controversies attached, this itself shouldn’t really be controversial. Anyone who’s tempted to pick a fight over it is either a) nitpicking pedantic details that I would cover if an article like this were the place for footnotes, or b) hasn’t understood it properly. You can be a liberal, a conservative, or anything in between and agree with the above.

Now for the controvertible stuff. Why should anyone care about trade or federal deficits?

In a nutshell, because there’s no such thing as a free lunch.

This concept is something one normally hears from the right, but it’s not a right-wing idea per se. They just find it a more useful trope of propaganda right now.

When America runs a trade deficit, this means we’re getting imports we haven’t earned by producing exports. So we’re getting something for nothing. Or at least it seems that way.

Same deal when we run a federal deficit. We get to have all this spending without having to pay taxes to finance it. It looks like free money.

Only it isn’t, of course. And this applies to both deficits.

When we run a trade deficit, we must make up the difference between what we import and what we export by either a) going into debt to foreigners, or b) selling off existing wealth to them.

When we run a federal deficit, the U.S. government has to borrow the money, by selling off Treasury Bills and other debt instruments.

See where this is going? There is no magic money tree for either deficit. Each is a way of pushing costs around, not making them go away. Which is exactly what a common-sense appreciation of the non-existence of unicorns and free lunches would lead one to expect.

Now for the politics.

Obviously, there’s a left-vs.-right bone of contention about whether a federal deficit should be closed by reducing expenditures or increasing revenues. That’s what elections are for.

Less obviously, there’s a disagreement as to whether Keynesianism (named after Maynard Keynes, a British economist who died in 1946) is true. This basically comes down to the idea—pace the subtleties—that running a federal deficit during recessions will help blunt the severity of the recession and spur recovery.

Now I personally believe, based on a whole pile of historical evidence dating back to the 1930s, that Keynesianism is, to at least a first approximation, quite simply true, and therefore shouldn’t be a partisan bone of contention. Richard Nixon, among others on the right, agreed with this. But unfortunately, there are today people on the right who insist on manufacturing an argument here when they really should be arguing about other, legitimately disputable, parts of the picture.

Oddly enough, some of the same people who deny Keynesianism in theory are also counting on it in practice to blackmail the Obama administration with the fear that the economy will slump if the so-called “fiscal cliff” is allowed to happen.

What’s that? The fiscal cliff is the fact that, based on legislation passed in 2011, if Congress doesn’t agree to a better long-term deficit-reduction plan, there will be automatic budget cuts starting next year. Plus the Bush tax cuts, and a temporary payroll-tax cut, are scheduled to expire about the same time. The result? A sudden contraction of the federal deficit by about $500 billion in 2013 and $680 billion in 2014. Which is a recipe, according to Keynesian thinking, for tipping the economy back into recession.

What’s the connection of the trade deficit to all this? A couple of things.

For one thing, when America runs a trade deficit, we have to either borrow money from foreigners or sell off existing assets to them to cover the gap. And a lot of that borrowing and asset selling takes the form of federal debt instruments like T-bills. So our appetite for foreign credit to buy imports is related to our appetite for foreign credit to finance our government.

For another thing, the reason the fiscal cliff could tip us back into recession is that it would suddenly reduce so-called aggregate demand. That’s the economy’s total demand for goods and services. But a trade deficit does the same thing, because it means that demand for goods and services is being satisfied by foreign producers, not American ones. So output, jobs, and industries suffer the same way.

Right now, a lot of attention is being paid to the federal deficit. But it’s high time attention got paid to our other deficit. It all comes out in the wash in the end.

Ian Fletcher is the author of the new book Free Trade Doesn’t Work: What Should Replace It and Why (USBIC, $24.95)  He is an Adjunct Fellow at the San Francisco office of the U.S. Business and Industry Council, a Washington think tank founded in 1933.  He was previously an economist in private practice, mostly serving hedge funds and private equity firms. He may be contacted at

© 2012 Copyright  Ian Fletcher - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

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