Are Trade Deficits Really That Bad?

In a recent piece in The Nation Thomas Geoghegan argues fiercely that few points were made more emphatically by John Maynard Keynes than his opinion  that: “no country, ever, should run up any kind of trade deficit, much less the trade deficit on steroids we are running”, and that he even fought for a global currency: the bancor, that would push creditor countries like the United States to pull debtor countries out of debt.  Persistent trade deficits, argued Keynes (and, by extension, Georghegan), would frustrate the move toward full employment, via leakages in the economy which encourage import growth over exports, and hence, ultimately cost jobs.   So what’s the answer?

To be clear, like Thomas Geoghegan, we support policies to get us to a full employment economy.  But we’re not persuaded that his focus on trade deficit reduction is the right way to get us there. Nor do we share the increasingly prevalent view amongst Keynesians and others that we need for a new global currency – a new bancor – to minimize persistent US trade deficits.

First, let’s deal with the issue of a new international currency.  What about a “bancor” international currency? Fine. It requires an issuer. It requires international agreements on the conditions under which it is issued. It requires punishment of nations that violate agreements. That sounds a lot like the euro. It is the euro. Who wants to be the next Greece? With no volunteers, let us move on.

Let’s start by acknowledging that there is much that is correct in Geoghegan’s analysis:  it is the case that persistent trade deficits which run alongside non-expansionary fiscal policy, can be a recipe for disaster.  To explain this point a bit further, it’s important to take a step back.  We can divide the economy into 3 sectors: there is a private sector that includes both households and firms. There is a government sector that includes both the federal government as well as all levels of state and local governments. And there is a foreign sector that includes imports and exports; (in the simplest model, we can summarize that as net exports—the difference between imports and exports—although to be entirely accurate, we use the current account balance as the measure of the impact of the foreign sector on the balance of income and spending).

At the aggregate level, the dollar spending of all three sectors combined must equal the income received by the three sectors combined. Aggregate spending equals aggregate income. But there is no reason why any one sector must spend an amount exactly equal to its income. One sector can run a surplus (spend less than its income) so long as another runs a deficit (spends more than its income).

If households and businesses save, for example, $10 of every $100 they receive, then that $10 is lost from the expenditure stream. If households save by spending less than they earn, and businesses save by reinvesting less than their retained earnings, then the production level will be too high relative to demand and unsold inventories will grow. The result will be deferred consumption and firms laying off workers; that is, unless output is offset by rises in the trade sector (i.e. more exports).

Now, if the foreign sector is balanced and the private sector runs a surplus, this means by identity that the government sector runs a deficit. If today’s budget deficit warriors get their way, then we try to reduce the government deficit, which will slow down activity even further and, in the absence of a big increase in exports, you’ll get slower growth and HIGHER deficits, unless the private sector is willing to take on more debt, particularly given the way our trade sector is configured, whereby a trade surplus is not likely anytime soon.

But isn’t that the accumulation of private debt, a policy that got us into our current mess?

So why not try to increase exports?

There is no question that net exports boom adds to aggregate demand (the spending injection via exports is greater than the spending leakage via imports).  And it is also possible that the public budget balance could actually go towards surplus and the private domestic sector increase its saving ratio if net exports were strong enough.

But here’s the problem: It’s all very well to suggest that we should export more, but it takes two to tango, and if our trading partners (such as Germany, Japan or China) do not want to increase US imports, there’s very little the US can do. When I was living in Japan in the 1980s, this was a huge issue: the US tried to “force” Japan to revalue the yen (shades of China today), and pressured the Japanese into a whole host of liberalizing/deregulatory measures designed to increase US exports to Japan. Hardly any of them worked. Japan’s trade surpluses continued to expand.

There is also the issue of government restrictions at home. China would glad buy tons of our military hardware, but we restrict its sale on the grounds of national security. Since this is one of the areas where the US literally has a “cutting edge”, it makes export growth even more problematic.

Finally, you run into the old fallacy of composition argument: not every country can be a so-called “export superpower” as our President keeps urging on the US. As an example, consider Germany, which refuses to even run a current account deficit with its fellow European Union “partners” (even though this is arguably in Germany’s economic self-interest, as it would mitigate some of the strains currently being experienced in the euro zone periphery). Do we seriously expect the Germans to run big trade deficits with the US?

Remember, a trade deficit can only occur if the foreign sector desires to accumulate financial (or other) assets denominated in the currency of issue of the country with the trade deficit. This desire leads the foreign country (whichever it is) to deprive their own citizens of the use of their own resources (goods and services) and net ship them to the country that has the trade deficit, which, in turn, enjoys a net benefit (imports greater than exports). It also leads to a “race to the bottom” as far as wages go, since the exporting nation constantly has to squeeze domestic wages to ensure that the exports remain internationally competitive.  We work harder, but consume less.  By contrast, a trade deficit means that real benefits (imports) exceed real costs (exports) for the nation in question.

There is another way:  you can accommodate that trade deficit by running larger government deficits.  Given our current account deficit (and the corresponding demand leakage) to sustain anything like the level of aggregate demand required to reduce unemployment, rebuild our infrastructure, etc., that means our budget deficit has to be even larger to allow our private sector to save.

What I am going to say next will sound quite controversial. The US government transitioned from 2.5 per cent surplus in the late 1990s to a deficit near 11 per cent of GDP today, but it faces no insolvency constraint and no default risk. The reason this proposition is controversial is because we do face deficit hysteria in the US and a persistent threat by credit ratings agencies to downgrade US government debt (which S&P did about 6 weeks ago). Congress nearly refused to extend the self-imposed debt limit on the federal government—and it is still possible that the government might get shut down if Congress refuses to raise the limit in the future.

But is all of this deficit hysteria justified?  Well, let’s look at the history first: for the past 82 years, the US government’s budget has been in deficit of varying proportions of GDP over 80 per cent of the time. There is nothing insidious or inherently sinister about these deficits. Each time the government tried to push its budget into surplus, a major recession followed which forced the budget via the automatic stabilizers back into deficit, ultimately helping to put a floor on demand and prevent a recurrence of the Great Depression.

Additionally, as Geoghegan himself notes, all debt is not created equal. The expansion before the end of the Internet bubble crash in 2001, and the subsequent recovery in the 2001-2008 period (which had its roots in the housing bubble and massive financial fraud) were both largely products of an unprecedented private sector borrowing binge. Both businesses AND households borrowed (and spent) on an unprecedented scaleDuring the Clinton years, everybody – Democrats and Republicans alike – applauded the government budget surpluses because it meant that the government’s outstanding debt was being reduced. This celebration of the “virtues” of government budget surpluses from the Clinton era is a misguided paradigm that continues to hamper progressive policy making today. As the government budget moved to surplus during the latter years of the Clinton Presidency, the private sector’s deficit correspondingly grew larger: It was the mirror image to the budget surplus plus the current account deficit. The budget surplus meant by identity that the private sector was running a deficit.

Why is that? It is because budget surpluses suck income and wealth out of the private sector. As the budget surpluses grew, households and firms were going ever farther into debt, and they were losing their net wealth of government bonds. Even when the government went back into deficit, it was insufficient to offset the cumulative effect of huge private debt accumulation and rising trade deficits, both of which ultimately laid the foundations for the Great Financial Crash of 2008.

To re-emphasize the point which the President should be making day in and day out: It was NOT “profligate” government expenditures that created the current fiscal state of affairs. To the extent that the US has experienced any “government profligacy” over the past 3 years, it is because of our mindless bailout of Wall Street institutions (and note how conspicuously quiet today’s fiscal hawks were during that period when the Treasury and Federal Reserve established trillions of dollars of financial guarantees to fundamentally insolvent banking institutions). The real issue is that those who are better off don’t want to have government intervention in economic affairs unless it benefits them. When the government intervenes with bailouts, Wall Street stands with hat in hand.

The persistent resort to bailing out our fundamentally insolvent banking system is one of the factors that has done so much to discredit fiscal policy. We need a fresh approach:  The US needs jobs. A universal Job Guarantee program is a better approach than closing off our economy. The jobs would pay basic wages and benefits with a goal to provide a living wage. It would take all comers—anyone ready and willing to work, regardless of education, training, or experience. Adapt the jobs to the workers—as the late Hyman Minsky said, “take the workers as they are” and work them up to their ability, and then enhance their ability through on the job training.

There is no question that sock puppet politicians do have this proclivity toward crony capitalism and we recognize their proclivity toward wasteful spending and given goodies to their campaign contributors, and we argue  that “if you want to take this power back away from them” you must support an  Job Guarantee like mechanism that automatically adjusts to insure the private sector can actually realize its desired net nominal savings position…in other words, our proposal frees the system from political parasites while increasing the freedom of the private sector to achieve its goals.

The program needs to be funded by the central government. Wages would be paid directly to the bank accounts of participants for working in the program. Some national government funding of non-wage costs could be provided. I would decentralize the program, to allow local governments and not-for-profit service organizations to organize projects.

Before all the Weimar hyperinflation hyperventilists attack, let me also add that too much government spending can be inflationary and can create pressures on the currency. But by design a job guarantee program only hires people who want to work because they cannot find higher paying jobs elsewhere. It sets a wage floor but does not drive wages up. As such, it can never cause hyperinflation—it hires “off the bottom” at the program fixed wage, only up to the point of full employment. It never drives the economy beyond full employment, but it can offset the impact of trade deficits.

Government as employer of last resort would not be introducing another element of intrusive bureaucracy into our economy, but simply better utilizing the existing stock of unemployed, now dependent on the public purse – especially the chronically long term unemployed. The current system we have relies on unemployed labor and excess capacity to try to dampen wage and price increases; however, it pays unemployed labor for not working and allows that labor to depreciate and develop behaviors that act as a barrier to future private sector employment.  Social spending on the unemployed prevents aggregate demand from collapsing into a depression-like state, but little is done to enhance future growth and demand, which can be done via the JG program by providing them with employment, greater education and higher skill levels.

The JG program would allow for the elimination of many existing government welfare payments for anyone not specifically targeted for exemption, and would command greater political legitimacy, as society places a high value on work as the means through which individuals earn a livelihood. Minimum wage legislation would no longer be needed as it would be established via the JG. Labor would welcome the safety net of a guaranteed job, and business would recognize the benefit of a pool of available labor it could draw from at some spread to the government wage paid to JG employees. Additionally, the guaranteed public service job would be a counter- cyclical influence, automatically increasing government employment and spending as jobs were lost in the private sector, and decreasing government jobs and spending as the private sector expanded. It would therefore remain a permanent feature of our economy, in effect acting as a buffer stock to put a floor under unemployment, whilst maintaining price stability whereby government offers a fixed wage which does not “outbid” the private sector, but simply creates a stabilizing floor and thereby prevents deflation.

The Job Guarantee program is desired because a more or less free market system does not (and, perhaps, cannot) continuously generate true full employment.  No civilized nation should allow a large portion of its population to go without adequate food, clothing and shelter.  Best of all is that the program would be creating a stock of employed people, rather than a buffered stock of unemployed, where social capital depletes rapidly, and several long-term social pathologies develop.  The current policies clearly are not working; it’s time to try something that can put as many Americans as possible into productive employment.  If Keynes lived in a post gold standard world, this might well be the sort of policy he would support as well.

MARSHALL AUERBACK is a market analyst and commentator. He is a brainstruster for the Franklin and Eleanor Roosevelt Intitute. He can be reached at


Marshall Auerback is a market analyst and a research associate at the Levy Institute for Economics at Bard College (  His Twitter hashtag is @Mauerback