The current account of a country is, by definition, the difference between a country's national savings and national investment. A country that invests more than it saves has relatively high interest rates and rates of return which drag financial capital from overseas. This capital inflow appreciates the currency and reduces exports and raises imports. The trade deficit is the mirror of the capital inflow. Thus, the US current account deficit reflects the fact that the US government and private sector borrow to maintain investment and consumption.
The composition of exports and imports reflect a range of issues such as comparative advantage, trade policies and other policies that distort trade but to the extent trade distortions don't change the behaviour of US consumers, firms and government they don't change the trade balance. In other words, trade policies tend to change the composition of trade flows but not the overall trade balance.
BB comment: Donald's Trump's trade war thesis is built on false assumptions.
In a recent paper Andy Stoeckel and I analysed a range of Trump administration policies including a trade war scenario. We show that a minor global trade war in which tariffs rise by 10 per cent would reduce GDP of most countries between 1 per cent and 4.5 per cent, with the US losing 1.3 per cent of GDP and China 4.3 per cent of GDP. A 40 per cent change in tariffs would cause a deep global recession. The Smoot-Hawley tariff of 1930 comes to mind.
A much smarter response(than engaging in a trade war with the USA) – which might even have unintended positive consequences for the world outside the US economy – is to consider again the source of the US current account deficit.
For decades trillions of dollars of global savings have been pouring into buying US treasury bills and other government securities. This effectively subsidises the borrowing costs of the US government relative to what it would pay if it only had access to US domestic savings. It also drives down the cost of US corporations borrowing in domestic markets. This subsidy by foreigners to the US government has been made at the expense of investment that could have been made in any number of advanced and developing countries.
If the major creditor countries left their tariff rates unchanged and instead decided to sell their holdings of US government securities and invest in other countries, the US would quickly discover the fundamental error in the economic logic underpinning the Trump administration. The US dollar would drop sharply, US long bonds would rise by several hundred basis points until US savings rose and US investment fell so as to move the trade position closer to balance. US exports would rise and imports would fall. US firms, consumers and the government would be far worse off due to higher borrowing costs but they would sell more for cheaper prices to foreigners! The US would have to learn to live within its means if it no longer wanted to have the benefits of access to an open global trading system. The lesson would be that a country that leverages by borrowing for decades in order to sustain consumption and investment levels that are far removed from fundamentals eventually has to pay.
Warwick KcKibbin concludes as follows: "I doubt that any of this has escaped the leaders of the major countries who have advisers who have completed economics 101. I am just stating the obvious, with a hope of avoiding a potential conflict. " This might be a very tough lesson for Donald Trump.