Don’t like trade deficits? Then say hello to economic recession!

“The proposed tariffs should be dead on arrival. Let’s have larger trade deficits instead. Our trade partners are invested with us.” – Hirs

By Ed Hirs, energy economist, University of Houston

Trade deficits keep your mortgage rates low. Trade deficits help you buy your cars. Trade deficits pushed the U.S. stock and bond markets higher until the recent call for increased tariffs on aluminum and steel slammed markets.

The Trump administration claims that these tariffs are to protect American jobs and to benefit national security. This is backwards. Our trading partners are our leading investors, and trade deficits keep the U.S. out of war.

Ed Hirs, energy economist and professor, University of Houston.

The world economy is a network of flows — capital, goods and services going from one trading partner to another to another. Disrupting these flows will have consequences that many Americans do not readily see.

In 2017 the U.S. trade deficit was $566 billion, which means that we spent more on foreign goods and services than our trading partners spent with us. It also means that we can afford to make the purchases. But where did that $566 billion in dollars go once it was abroad? The answer is that for it to be valuable to the recipient — think China, Russia, South Korea and other large trading partners — those dollars were exchanged for other currencies. Larger trade deficits mean more dollars abroad, which will drive down the value of the dollar making our goods more competitive abroad.

If left alone over time, trade deficits can be self-correcting as the value of the dollar falls. But our trading partners and currency traders do not want to hold a depreciating asset. They ultimately exchange these dollars by purchasing U.S. real estate, stocks and bonds. The U.S. Treasury estimates that foreign investors hold more than $18.4 trillion in U.S. stocks and bonds alone.

The world’s largest issuer of securities is the United States, and we will soon have $21 trillion in debt outstanding. As of November 2017, our trading partners held $6.3 trillion of that debt. Without our trading partners supporting federal deficit spending, interest rates and the cost of borrowing in the U.S. will rise. Sales of homes and cars will plummet as interest rates rise across the board.

If the foreign investors exit U.S. stocks and bonds, the additional carnage will be legion as all asset prices will begin to fall. Imagine the Dow Jones Industrial Average falling below 10,000.

No one argues that the U.S. has a level playing field with our trading partners. Incremental gains from renegotiated trade deals can be realized and can be pursued. But the broad, sweeping unilateral imposition of tariffs by the U.S. will hurt us even more than it will hurt our trading partners.

To the extent that our trading partners are unable to match the tariff increase with a further price decrease, demand for their steel and aluminum will fall and their economies may enter recessions. If so, they will buy fewer U.S. goods and services, erect their own retaliatory trade measures to protect their domestic economies, and liquidate their holdings of dollars and U.S. assets. We will enter a vicious economic spiral not seen since the Smoot-Hawley Tariff Act of 1930 plunged the U.S. even deeper into the Great Depression.

If the administration makes good on its tariffs proposals, the fiscal irresponsibility of the recent tax cut bill ($1.5 trillion in added debt) and the recent spending bill (which added $500 billion more in debt) will come home to roost during the current administration with increased interest rates, increased unemployment and a staggering recession.

The administration argues that the new proposed tariffs are also for national security. Strategically speaking, which one of our trading partners would attack the U.S. while owning trillions of dollars of U.S. real estate, stocks and bonds? That these partners have found investment opportunities in the U.S. that dominate what they could earn in their own economies means that they are invested in the future of America. Even if we pick one aggressor who is not invested in U.S., its trading partners certainly are. It is a networked world economy. Having more foreign investments in the U.S. should lessen the risks of war.

The administration’s cable news presentations of soup cans do not change economic history and cannot change economic realities. Choking off one part of a network will wreak damage to all who are part of the network — allies and foes alike. The proposed tariffs should be dead on arrival. Let’s have larger trade deficits instead. Our trade partners are invested with us.

This op-ed originally appeared in the Houston Chronicle on March 7, 2018.

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