The failure of Trump’s trade and manufacturing policy
A shorter version of this post appeared in the Detroit News on 12/2/2018: GM Cutbacks a result of overvalued dollar.
Last month, General Motors announced plant closures in the U.S. that could lead to roughly 14,700 layoffs by the end of 2019. The shutdowns will have the biggest impact in industrial states like Ohio and Michigan, where key plants in Detroit-Hamtramck, Lordstown, and Warren are being closed. But the closures also have wider implications for American industry—and not just the machine shops and fabricators that produce rubber, steel, and glass components for auto assembly. America’s manufacturers are all struggling with the same issue—an overvalued dollar that puts them at risk from rising trade deficits. And it all derives from flawed Trump administration economic policies.
Trump’s tax cuts and increased government spending for defense and nondefense needs are widening the U.S. budget deficit, which will top $1 trillion in 2020 (5 percent of GDP). On top of that, Trump’s tariffs on China have backfired. China has reduced the value of the yuan 10 percent this year, and its trade surplus with the United States has increased 10 percent over the same period last year—even faster than the overall U.S. goods trade deficit, which is up 9.4 percent in the same period. The IMF projects that the overall U.S. current account deficit (the broadest measure of trade in goods, services and income) will nearly double over the next four years.
As a result of the rising dollar and increasing current account deficit, the U.S. goods trade deficit will increase to between $1.2 trillion and $2 trillion by 2020, an increase of $400 billion to $1.2 trillion above the $807 billion U.S. goods trade deficit in 2017, as shown below. This will directly eliminate between 2.5 and 7.5 million U.S. jobs, mostly in manufacturing (because 85 percent of U.S. goods trade consists of manufactured products). The collapse in output, especially in the capital intensive manufacturing sector, will decimate investment—and taken together, both will result in large additional job losses as income and spending collapse, resulting in a steep recession if nothing is done to reduce the over-valued dollar. The dollar must fall by at least 25 to 30 percent (on a real, trade-weighted basis) to rebalance U.S. trade and avert the coming trade tsunami that’s baked into the economy as a result of the rising trade deficit.
To see why the GM announcement is the canary in the coal mine, consider its position. Why is the company taking such a drastic step? CEO Mary Barra says the company is trying to make itself leaner, and shifting resources toward newer electric vehicles and self-driving cars.
But that’s not the entire issue. The U.S. dollar is now substantially overvalued—which keeps making imports cheaper and U.S. exports more expensive. GM is clearly trying to protect itself against a future economic downturn. It’s well known in the business community that the prospects for a recession in the next few years are quite high. This is the chickens coming home to roost on the broader Trump economic policies.
The dollar’s overvaluation stems from a rather grievous irony. The United States is the epicenter of the world’s financial markets, with overseas investors continually purchasing dollar-denominated assets and securities. That’s certainly good for Wall Street. But it invites a downside.
A continuing influx of foreign capital is driving up demand for the dollar. Trump appointees Jay Powell (Chair) and Randy Quarles (Vice Chair) at the Fed also bear substantial responsibility for recent increases in the dollar, due rapid interest rate increases within the past year, which have made U.S. investments more attractive to foreign investors.
And the resulting rise in the dollar is making America’s exports—including the cars built by General Motors—more expensive for overseas consumers. It also makes imported goods cheaper in the U.S. market. These low-cost imports deliver growing profits for multinational operations like Apple—and yield a triple-whammy for U.S. manufacturers competing against imports that keep getting cheaper.
The situation has gotten worse of late because President Trump’s economic policies have actually reinforced the dollar’s rise. Last year’s tax cuts and 2018’s spending increases are swelling a budget deficit projected to exceed $1 trillion by 2020. Just as textbooks predict, increased federal borrowing (along with Fed policy) is driving up short- and long-term interest rates, attracting even more foreign capital—and further strengthening the dollar.
The president’s policies are now backfiring on GM and domestic manufacturers because the dollar has increased 5.4 percent in value in the past year alone. And China has devalued its currency, the yuan by 10 percent this year—more than offsetting the impact of the president’s tariffs. Thus the irony that President Trump’s tax cuts and increased defense spending have short-changed working Americans even as they’ve swelled corporate coffers. The administration believes tax cuts will stimulate investment and job creation. But companies—including GM—have used the proceeds to increase dividend payments, buybacks, and CEO compensation—not worker wages.
U.S. real, trade-weighted, dollar has gained 20% since 2013, including 5.4% since January 2018
Source: Board of Governors of the Federal Reserve of the Federal Reserve System, Foreign Exchange Rates -- H.10. Price adjusted Broad dollar index -- monthly index.
Chinese yuan has fallen 10 percent against the U.S. dollar since early April, 2018
Source: Board of Governors of the Federal Reserve, Foreign Exchange Rates – H.10: Historical Rates for the Chinese Yuan Renminbi
Because the dollar keeps rising, the International Monetary Fund (IMF) foresees a perfect storm. Rising imports will drive America’s current account deficit up from $449 billion in 2017 to more than $800 billion in 2022. Concurrently, the U.S. goods trade deficit could double in the next four years, rising from $807 billion in 2017 to between $1.2 and $2.0 trillion. Such a massive increase could potentially tip the nation into a new recession.
The Trump bump in the U.S. trade deficit, 2012–2022
|U.S. current account deficit ($billion)||U.S. current account, share of GDP|
Source: EPI analysis of International Monetary Fund, World Economic Outlook Database, Data by Countries. October 2018. Data after 2016 are IMF estimates.
Growing gap between current account and goods trade deficits bodes ill for U.S. manufacturing
Historically, and especially between 2000 and 2006, the U.S. current account and goods trade balances tended to track one-another nearly dollar for dollar. However, since 2007, there has been a growing gap between these two measures, with the goods trade deficit rapidly increasing relative to the current account deficit, as shown below. There are three reasons for this. First, since the mid-2000s, the United States has begun to run a sizeable surplus in “services” trade (not shown), which reached $243 billion (1.3 percent of U.S. GDP) in 2017. To some, this sounds like the desirable symbol of a “modern” economy. But in fact, over half of the U.S. services surplus is in three categories: financial services (banks, brokers, and credit card companies, 23 percent); professional and management consulting (15 percent); and charges for intellectual property (13 percent). These “services” are simply rents, or profits accruing to investors, and high-wage industries in finance and business consulting. They generate few good jobs for non-college educated workers, of the type supported by manufacturing, in the domestic economy. Of the rest, “travel” is the largest single category, which is dominated by education (another high-wage sector, 13 percent) and other personal travel (18 percent), but the later primarily supports low wage jobs in industries such as accommodations and food services.
The second major, growing component of trade is growth of “primary” income, including investment income and payments to employees (such as foreign executives), which generated $217 billion of net income (1.3 percent of GDP) in 2017. The dangerous irony of the modern global economy is that outsourcing, which has shifted production to foreign countries, has generated rapidly growing flows of foreign profits and rents (royalties, profits, and wages paid in banking and consulting services) to U.S. and foreign multinationals. These flows of capital income have directly offset the growing U.S. deficits in goods trade, which have displaced millions of manufacturing jobs. In total the United States has lost 5 million manufacturing jobs since 1998, most due to growing trade deficits with China and other large exporters. The troubling irony is that outsourcing is generating a flow of profits and services income that is offsetting growing goods trade deficits in the broadest trade measure (the current account deficit), effectively disguising the negative impacts of globalization on the domestic economy.
The third major component shift in U.S. trade patterns has occurred in petroleum products. A decade ago, in the mid-2000s, the United States ran a trade deficit in crude and refined petroleum which reached 2.1 percent of GDP in 2006 (peaking at 2.8 percent of GDP in 2008). However, the rise of fracking in the United States, combined with a decline in world oil prices and rising U.S. exports of refined petroleum products, has reduced the U.S. trade deficit in crude and refined petroleum to only 0.3 percent of GDP. The U.S. trade deficit in non-oil goods (which is dominated by trade in manufactured products) reached near-peak levels of $732 billion in 2017 (3.8 percent of GDP). This is much larger than the previous peak of $520 billion in 2006, which was also 3.8 percent of GDP. Thus, the rise in U.S. oil production has also tended to obscure the impacts of the rapid growth in the U.S. non-oil goods trade deficit, over the past decade. The non-oil goods trade deficit is poised to explode as a direct result of the failure of Trump’s trade and economic policies.
On the other hand, The U.S. current account deficit—the broadest measure of our trade in goods, services and income—was widely viewed as relatively stable in 2017 at only 2.4 percent of GDP (versus an all-time peak of 5.8 percent of GDP in 2006). Thus, today’s current account trade deficit is viewed as manageable by most economists. However, in manufacturing and other traded goods sectors (such as farming), the goods trade deficit (and especially in non-oil goods) is reaching crisis levels. This explains why it is so important to focus on future trends in goods trade, as shown in the bottom two lines of Figure D, below.
U.S. current account and goods trade balance, actual and forecast, 2010–2023
|Alternate goods trade balance Estimate*||IMF WEO goods trade balance||IMF WEO current account balance|
*Based on IMF CA forecast and trend of the ratio of the actual trade balance to current account forecast.
Note: Data labels are rounded to the nearest hundred.
Source: EPI analysis of IMF World Economic Outlook Database, October 2018
The U.S. goods trade balance forecasts (for the 2018 through 2023) shown in Figure D are based on two alternative projections. The first projection (shown in red) is based on IMF World Economic Outlook (WEO) projections of trends in the volume of goods exports and imports. However, these are overly conservative because they fail to reflect changes in import and export prices. The second “alternate goods trade balance estimate” is based on the trend growth in the ration of the goods trade to the current account balance (this ratio increased 3.4 percent per year in the 2018-2023 period).
Both scenarios lead to goods trade deficits well of at least $1.2 trillion by 2023, and possibly as much as $2.0 trillion. Given the rapid decline in U.S. trade deficits in petroleum projects, these deficits will be devastating for the U.S. manufacturing sector, likely giving rise to massive job loss on the scale experience in the 2000-2007 period, when 3.5 million U.S. manufacturing jobs were lost.
There’s still time to sort through the mess, however. Washington can take coordinated action to lower the value of the dollar by at least 25 to 30 percent. The last time the United States intentionally engineered a major currency realignment was with the Reagan administration in 1985. Treasury Secretary James Baker negotiated the Plaza Accord with Japan, France, Germany, and the United Kingdom—achieving a 30 percent depreciation in the U.S. dollar. The U.S. goods and service trade deficit subsequently fell from $122 billion in 1985, and a peak of $152 billion in 1987, to $31 billion in 1991(the trade deficit usually worsens for two years after the dollar depreciates, and then improves rapidly, in what is known as the j-curve effect).
Notably, House Democrats played a key role in the Plaza Accord. The threat of Rostenkowski-Gephardt trade legislation—which would have imposed a 25 percent surcharge on imports from Japan, Brazil, Korea, Taiwan, and others—motivated finance ministers to work with Baker on a currency deal. The threat of high, permanent tariffs lead foreign officials to seek out alternatives that would rebalance trade without introducing new trade barriers.
With GM and other manufacturers now struggling, Democrats should see an opportunity to focus on middle class jobs—starting with a revaluation of the U.S. dollar. They can force the president’s hand by threatening to impose broad, across the board tariffs on all countries with large, persistent, global trade surpluses, including China, Japan, Korea and Germany and other big surplus countries in Europe (Netherlands, Sweden, Switzerland) or the entire E.U. There are also other tools to rebalance the dollar, such as taxing foreign capital inflows. But it is perhaps best to confront a man such as Trump in a language the he understands: with the threat of higher, across-the-board tariffs. The \president campaigned on rebuilding American manufacturing, and delivering more jobs and higher wages. Instead, it could be the newly Democratic House that actually achieves this—by pressing 1980s-style trade legislation as the impetus to revalue the dollar in the same way the Reagan administration wisely did, 30 years ago.
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