Increased U.S. trade deficit in 2017 illustrates dangers of ignoring the overvalued dollar

The U.S. Census Bureau reported that the annual U.S. trade deficit in goods and services increased from $504.8 billion to $566.1 billion from 2016 to 2017, an increase of $61.2 billion (12.1 percent). The rapid growth of the overall U.S. trade deficit reflects the failure of Trump administration trade policies to materially affect trade flows in its first year, and its failure to address currency misalignment and prolonged overvaluation of the U.S. dollar.

The U.S. goods trade deficit increased from $752.5 billion in 2016 to $810.0 billion in 2017, an increase of $57.5 billion (7.6 percent). The U.S. goods trade deficit is dominated by the trade deficit in manufactured products (including re-exports), which increased from $648.7 billion in 2016 to $699.8 in 2017, an increase of $51.1 billion (7.9 percent). Rapidly growing trade deficits in manufactured goods are a threat to future employment in this sector, which remains a large employer despite decades of policy-inflicted decline.

The U.S. trade deficit with China reached a new record of $375.2 billion in 2017, up from $347 billion in 2016, an increase of $28.2 billion (8.1 percent). China is a particular source of concern in trade in steel and aluminum, industries in which that country has accumulated massive amounts of subsidized, and often state-owned excess production capacity, over the past two decades. The president needs to promptly take trade action in pending national security investigations in these sectors.

The remainder of the goods trade deficit is composed of trade in petroleum and other energy products, and miscellaneous transactions. The United States also had a small trade surplus in agricultural commodities, which reached $22.1 billion (including re-exports) in 2017. The U.S. surplus in services trade declined from $247.7 billion in 2016 to $244.0 billion in 2017, a decline of $3.7 billion (1.5 percent).

The most important cause of large and growing U.S. trade deficits is persistent currency undervaluation by countries such as China, Japan, and Korea, which have run large, persistent trade surpluses, as well as large structural surpluses accumulated by Germany. The real, trade-weighted value of the U.S. dollar increased sharply in 2014 and 2015, as shown below. Although the dollar declined in the 12 months ending in January 2018, on average it was 16 percent higher than in 2013. The dollar affects trade flows with a lag of about two years, and the dollar increase in 2014–15 was the most important cause of the sharp increase in the trade deficit in 2017. The United States is likely to incur growing trade deficits unless and until steps are taken to re-align the dollar with the undervalued currencies of countries with persistent trade surpluses. Recent dollar depreciation is unlikely to constitute a durable solution to the trade deficit unless it is reinforced by a policy commitment to keep it at competitive levels. The Trump tax cuts will add more than $1 trillion to U.S. fiscal deficits over the next decade, putting upward pressure on interest rates and the U.S. dollar. Absent aggressive efforts to reduce the overvalued dollar, policies of trading partners and the vagaries of financial markets will soon lead to a rising dollar, putting continued upward pressure on the trade deficit, and downward pressure on employment and output in U.S. manufacturing.

Figure A

Real U.S. trade weighted exchange rate, January 2013–January 2018

date Rate
Jan-2013 83.0363
Feb-2013 83.9241
Mar-2013 84.315
Apr-2013 83.7138
May-2013 84.0192
Jun-2013 84.6143
Jul-2013 85.0939
Aug-2013 84.9919
Sep-2013 84.6753
Oct-2013 83.7143
Nov-2013 84.3853
Dec-2013 84.5551
Jan-2014 85.3761
Feb-2014 85.5479
Mar-2014 85.4196
Apr-2014 85.0183
May-2014 84.6656
Jun-2014 84.6916
Jul-2014 84.5124
Aug-2014 85.1022
Sep-2014 86.3188
Oct-2014 87.3019
Nov-2014 88.5769
Dec-2014 90.308
Jan-2015 91.9088
Feb-2015 93.0621
Mar-2015 94.6773
Apr-2015 93.7179
May-2015 93.0406
Jun-2015 93.7427
Jul-2015 95.3762
Aug-2015 96.9569
Sep-2015 97.5647
Oct-2015 96.6544
Nov-2015 98.1305
Dec-2015 98.8659
Jan-2016 101.164
Feb-2016 99.8355
Mar-2016 97.7441
Apr-2016 96.393
May-2016 97.4102
Jun-2016 97.7322
Jul-2016 98.3001
Aug-2016 97.5043
Sep-2016 98.3333
Oct-2016 99.2668
Nov-2016 101.642
Dec-2016 103.261
Jan-2017 103.235
Feb-2017 101.881
Mar-2017 101.041
Apr-2017 100.165
May-2017 99.499
Jun-2017 98.0753
Jul-2017 96.6715
Aug-2017 95.6656
Sep-2017 95.1607
Oct-2017 96.7406
Nov-2017 96.9578
Dec-2017 96.5958
Jan-2018 94.3494
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Source: Board of Governors of the Federal Reserve, "Price-adjusted Broad Dollar Index -- Monthly Index"

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