Most economists recognize that the economy is still suffering from excessive unemployment. In fact, many acknowledge that excess unemployment has been a problem for some time. Even Lawrence Summers, who was treasury secretary under President Bill Clinton and head of the National Economic Council under President Barack Obama, now acknowledges that shortfalls in demand have been an ongoing problem for close to two decades.
Summers and others often refer to this as a problem of secular stagnation. The idea is that the economy is not generating enough demand to sustain full employment. A big part of this story is that the upward redistribution of income we have seen in recent decades tends to reduce overall consumption. The rich people who have been getting the money don’t spend as large a share of their income as the middle class and poor people who have been losing it.
This is a plausible story that I wrote about a few years ago in a book on the rise and fall of the bubble economy. However, this upward redistribution is only part of the explanation of the shortfall in demand. The trade deficit is a much bigger part of the picture, but for some reason few policy makers want to discuss it.
The story is simple: If we have a trade deficit, it means that we are spending more in other countries than foreigners are spending in the United States. The deficit implies a loss of demand for the United States. Currently the trade deficit is running at more than $500 billion a year, or 3 percent of GDP.
From the standpoint of generating demand in the U.S. economy, this is equivalent to people collectively taking $500 billion out of their paychecks and stuffing it under their mattress. It has the same impact on demand in the United States if people spend their money in other countries as if they don’t spend it all.
While there are many areas of dispute in economics, the impact of the trade deficit on demand is not one of them. If an economy is operating below its potential level of output — in other words, if there is unemployment because demand is not high enough — a trade deficit further reduces demand, making the unemployment problem worse. Yet in just the last week both The Washington Post and The New York Times ran pieces questioning whether consumption demand would be sufficient to sustain growth. Neither of these pieces had a word about the trade deficit as being part of the problem.
The mechanism for fixing the trade deficit is not complicated. Essentially it means lowering the dollar against other currencies. While we have run trade deficits for the last three decades, the trade deficit was generally modest until a dramatic rise in the dollar’s value in the late 1990s. This caused the trade deficit to increase from around 1 percent of GDP in the mid-1990s to a peak of almost 6 percent of GDP in 2005.
Since 2005, a decline in the dollar, coupled with the weakness of the U.S. economy, has brought the trade deficit down to its current level of around 3 percent of GDP, but this is still a huge drain on the economy. With the dollar now rising against the currencies of our trading partners, the deficit is likely to get worse in the immediate future rather than better.
Goldman Sachs recently estimated that the rise in the dollar that we saw as of last month (it has since risen further) would trim between 0.2 and 0.3 percentage points off GDP over the next two years. That translates into a loss of roughly 350,000 jobs.
The lack of interest in the trade deficit among policy makers might be explained by the balance of winners and losers in this story. A higher-valued dollar makes traded items, primarily U.S. manufactured goods, less competitive in the world economy. That costs jobs in the manufacturing sector and lowers wages. The loss of jobs and lower wages in manufacturing spills over to other sectors. This leads to lower wages for the less-educated segment of the workforce more generally. That’s bad news for the roughly two-thirds of the workforce without a college degree. These are the losers from a trade deficit.
But there are winners. The financial sector is happy with a higher-valued dollar since it means less risk of inflation and investor money goes further in overseas deals. Importers such as Walmart, which have invested heavily in establishing low-cost supply chains, also are happy to see the dollar rise. And people who are more prone to take vacations overseas, such as reporters who write about economics and congressional staffers who help design policy, are also likely to be pleased with a higher-valued dollar.
With this balance of winners and losers, it is not surprising that we don’t hear much about the overvalued dollar and the trade deficit.