U.S. Trade Deficit: Myths and Realities

List of Key Chapter Titles

1. External Imbalances and National Wealth: The Fundamental Relationship
2. Direct Drivers of the U.S. Net External Position
3. Three Views on the External Origins of the U.S. Trade Deficit
4. The Impact of Commercial Policy
5. The Global Role of the Dollar
6. Foreign Capital Inflows as the Primary Causal Factor
7. Re-examining the U.S. Current Account Deficit, 1998-2008
8. Evidence of Global Imbalances
9. Evidence from Interest Rates and Stock Prices
10. The Dollar's Long-Term Decline, Exports, and Imports
11. A More Complex Narrative
12. Concerns Over the Trade Deficit and Policy Options for Reducing It

Document Introduction

This report, authored by Maurice Obstfeld of the Peterson Institute for International Economics, aims to systematically deconstruct three mainstream myths surrounding the United States' persistent trade deficit and, based on macroeconomic theory and detailed data, reveal the complex reality behind it. The report notes that although reducing the trade deficit has become a bipartisan policy priority in the United States, especially with the Trump administration's plans for broad tariff interventions, there is a fundamental misperception regarding its root causes.

The report first establishes an analytical framework for understanding the dynamic relationship between trade deficits and national wealth, emphasizing the identity that net exports equal the difference between domestic output and domestic absorption. Building on this, it provides an in-depth analysis of the evolution of the U.S. net international investment position, pointing out that, in addition to the current account deficit, asset price changes and exchange rate fluctuations are also key drivers of the U.S. net external liabilities. Data shows that despite the U.S. net international investment position being negative and large in scale, its net income from overseas investments has long been positive, partly attributable to the so-called "exorbitant privilege," although this advantage may be waning.

The core section of the report refutes three common myths one by one: First, that trade liberalization is the main cause of the overall U.S. trade deficit. By analyzing bilateral trade data following NAFTA and China's attainment of Permanent Normal Trade Relations, the report argues that specific trade agreements primarily affect bilateral trade patterns, not the overall deficit, and that tariffs at the macroeconomic level may fail to effectively improve the trade balance due to offsetting effects such as currency appreciation. Second, that the dollar's reserve currency status forces the U.S. to supply dollars to the world through trade deficits. The report demonstrates and shows that the world can acquire dollar assets through asset swaps rather than goods trade, and that global demand for dollar reserves is not mechanically linked to persistent U.S. deficits. Third, that the U.S. deficit is entirely caused by foreign capital inflows, to which the U.S. can only passively adapt. By introducing the classic Metzler two-region model, the report clarifies that capital flows are jointly determined by domestic and foreign savings and investment decisions; the U.S. is not a helpless victim of external shocks, and its domestic policies (such as fiscal austerity) can proactively respond to such shocks.

The report uses the period of record U.S. trade deficits from 1998-2008 as an in-depth case study. By examining the counterparts to global imbalances, trends in interest rates and asset prices, and data on the dollar exchange rate and trade flows, the report challenges the dominant "global savings glut" explanation for that period. The analysis indicates that, particularly between 2002 and 2008, domestic U.S. factors—such as easy financial conditions, the housing bubble, and fiscal and monetary policies—played a crucial role in driving the widening deficit. Furthermore, the dollar's sustained depreciation during this period contradicts the narrative that foreign capital inflows pushed up the dollar and thereby expanded the deficit.

Finally, the report explores policy options for reducing the trade deficit and their effectiveness. It points out that simply blaming the decline in manufacturing employment on the trade deficit confuses cause and effect. In a full-employment economy, tariffs neither guarantee an improved trade balance nor necessarily create manufacturing jobs. Other potential policy tools, such as taxes on capital inflows or artificially inducing dollar depreciation, face implementation challenges, side effects, or obstacles to international cooperation. The report argues that fiscal austerity is an option that can both curb domestic demand and reduce the trade deficit, while also lowering the risks associated with the U.S.'s massive external liabilities (especially government debt), and may simultaneously alleviate political pressure for disruptive trade policies.