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Think the Trade Deficit Couldn’t Get Any Worse? Think Again

For a country that has not run a trade surplus since Gerald Ford was in office 40 years ago, the United States is surprisingly optimistic in its widespread belief that the trade deficit is going to eventually correct itself. After all, as tidy macroeconomic models of international trade show, a nation’s trade deficit should lower the value of its currency, lowering the cost of exports and raising  the cost of imports, thereby gradually reversing the deficit. After all, the models show that in the long term, current accounts must balance.

As Martin Feldstein, former Chairman of the Reagan administration Council of Economic Advisors, predicts:

“The United States cannot continue to have annual trade deficits of more than $100 billion, financed by an ever-increasing inflow of foreign capital. The U.S. trade deficit will therefore soon have to shrink and, as it does, the other countries of the world will experience a corresponding reduction in their trade surpluses. Indeed, within the next decade the United States will undoubtedly exchange its trade deficit for a trade surplus.”

Unfortunately, Feldstein wrote this in 1987.

Far from his predictions coming true, the U.S. trade imbalance has only deepened and spread across sectors. Even more discouraging, at the time the U.S. at least enjoyed a trade surplus in advanced technology manufactured goods, but that has also become a deficit further eroding our leadership in innovation and technology.

Twenty-seven years after Feldstein’s optimistic economics lesson, we still have the exact same approach to our now $500 billion trade deficit. If we are just patient, dictates the prevailing logic, international market forces will shrink the trade deficit and lead to a trade surplus to allow us to pay off the accumulated current account debt. Never mind that the deficit is even larger than it was in 1987 as a share of GDP, or that during the 2000s America lost a greater share of its manufacturing jobs than it did during the Great Depression.

Not only do we not see signs of this happening, despite widespread declarations of a manufacturing renaissance, but the deficit is continuing to grow. Third quarter numbers just released show that America’s trade deficit is the largest ever, with the trade gap between America’s exports and imports widening by 9 percent. Indeed, for the first time, China is exporting twice as many manufactured goods to the United States as we send back to China.

So why was Feldstein wrong?  Why didn’t currency markets work the way they were supposed to and force a decline in the value of the dollar? In part it is because the dollar has been the global reserve currency and therefore maintains its higher value because markets around the world have faith in it.  But it has also remained strong because of a refusal from even the most free-market of advocates to support free markets when it comes to currency.  This is coupled with economic policies designed to keep the value of the dollar high, which helps savers and financiers, but hurts producers and workers, promoting Wall Street instead of “Industrial Street.” This explains how in the face of massive trade deficits and soaring unemployment, President Obama’s Treasury Secretary, Timothy Geithner, could proclaim that “we will never weaken our currency.” Perhaps he can say this because amazingly he did not see a “contradiction between the U.S.’s policy of bolstering its exports and its strong-dollar policy.”

And let’s be clear, Geithner is not an anomaly. Since the mid-1970s, a strong dollar has been the stated policy of every administration, Republican or Democrat. Or as President George W. Bush made clear: “We’re strong dollar people in this administration, and have always been for a strong dollar.” In the rare instance where a Washington official did not support the strong dollar consensus, the pressure was on. As former Bush administration Treasury secretary Paul O’Neill stated: “when I was Secretary of the Treasury I was not supposed to say anything but ‘strong dollar, strong dollar.’ I argued then and would argue now that the idea of a strong dollar policy is a vacuous notion.”

For these and other heretical views, O’Neill was replaced by someone who knew the right tune. Interestingly, unlike most recent Treasury secretaries who either came from Wall Street (for example, Nicholas Brady, Robert Rubin, Henry Paulson, and Tim Geithner) or were financial economists (Larry Summers), O’Neill came from industry, having served as CEO of Alcoa, a metals firm. As such, he knew firsthand the negative effect of an overly strong dollar on industrial competitiveness. To be sure, a stronger dollar means consumers pay less for imports, but that is a bit akin to saying that consumers are better off when they don’t pay their monthly credit card bills in full. They are better off in the short term, but at some point, the day of reckoning arrives when the full bill must be paid.

So what we should have learned after 40 years of unrivaled trade deficits is this: 1) the United States is in international competition that only gets stiffer ever year; 2) the growing trade deficit reflects not a lack of national savings as neoclassical economists claim but that we are being outcompeted (having the highest corporate tax rate in the world doesn’t help matters); 3) the trade deficit matters because it slows growth, limits productivity, and represents a debt that future generations must eventually pay through less consumption; and 4) only a robust national traded sector strategy will get us out of this mess. We must scrape for every victory to gradually pull ourselves out of the 40-year ditch.

Unfortunately, we currently seem set on doing the exact opposite, taking steps to shoot ourselves in the foot, not only failing bolster our traded sector industries through regulatory reform, expanding domestic energy supplies, and reducing of the effective tax rate but allowing ideology to threaten the basic measures of support we do provide to help our exporters access global markets.

In particular, the United States Export-Import Bank (Ex-Im Bank) has become the target of unprecedented opposition.  While it was up for a five year extension this fall, the Ex-Im Bank was instead given a 9-month extension to delay the debate, with opponents attempting to set up a coalition to cut the Bank’s charter this coming spring. Doing so would be a blow for the U.S. export economy, which is already struggling, limiting the ability of American companies to reach foreign markets and reducing foreign capacity to access the credit they need to buy American goods. Failing to extend the Ex-Im Bank’s charter would have a potentially irreversible negative impact on American manufactures and exports in a wide variety of industries. Rather than “leveling the playing field” for domestic competition, cutting the Ex-Im Bank would create even more obstacles for U.S. companies to access and compete in an uneven global playing field, moving the United States further away from closing the trade deficit. As in most cases of misguided policy proposals, there are two sources for bad policy: ideology and interests.

Regarding ideology, an increasing number of Americans, including unfortunately the chair of the House Financial Services Committee Jeb Hensarling (R-TX), see dismantling Ex-Im as an imperative in the fight against “big government”.  This is despite the fact that the Bank, far from committing the unspeakable crime of “crony capitalism” provides tools that enable American firms of all sizes to export products to new markets while not costing taxpayers a dime.

But those in the interest camp have also asserted themselves. Delta Airlines has accused the Bank of leading to chronic overcapacity in the airline industry, reducing Delta’s ability to compete. But this is simply wrong, as ITIF has written about previously. In fact, new data shows that the airline industry is actually now at undercapacity. The average flight taking off in the first eight months of 2014 was 84.1 percent full, up from 83.7 percent last year, representing a new high for the industry. As filling planes is the fastest way for an airline to make money (the marginal cost for an airline to fly a passenger is very low compared to the cost of making the trip in the first place), it’s no surprise that airline profits are up by 64 percent from a year ago.

Delta sued the Ex-Im Bank in 2011 for providing credit guarantees to Air India, which Delta claimed gave Air India a competitive edge over Delta. Unsurprisingly, Delta lost the case. As the court decision clarified, the airline industry is not suffering from chronic overcapacity, the Ex-Im Bank does not lend at below market rates, and Delta was not harmed by competition from airlines which finance planes through the Ex-Im Bank.

As we have seen, there is no evidence that the U.S. will lose its reserve status anytime soon, or that the Treasury Department will abandon its self-interested defense of a strong dollar or support efforts to press currency manipulators like China to raise the value of their currency. Taking these market mechanisms off the table is all the more reason for a proactive national traded sector strategy that includes expanding, not cutting, Ex-Im Bank financing authority. This is particularly important given that the Ex-Im Bank helps American exporters from being completely run off the rails, as our competitors also provide export finance assistance, and in much larger relative quantities. Far from economic theory guaranteeing a way to restore the trade balance, indicators point to the possibility of digging ourselves farther into the quagmire or chronic un-competitiveness if the 114th Congress fails to extend the charter of the Ex-Im Bank.

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