The final figures to be issued before the election for the federal government fiscal accounts and for the US trade accounts have now been published. The US Treasury published earlier today the Final Monthly Treasury Statement for the FY2020 fiscal year (fiscal years end September 30), and earlier this month the BEA and the Census Bureau issued their joint monthly report on US International Trade in Goods and Services, with trade data through August. The chart above shows the resulting fiscal deficit figures (as a share of GDP) for all fiscal years since FY1948, while a chart for the trade deficit will be presented and discussed below. The figures here update material that had been presented in a post from last month on Trump’s economic record.
The accounts show that the federal fiscal deficit as a share of GDP has reached a record level (other than during World War II), while the trade deficit in goods (in dollar amount, although not as a share of GDP) has also never been so high. Trump campaigned in 2016 arguing that these deficits were too high, that he would bring them down sharply, and indeed would pay off the entire federal government debt (then at over $19 trillion) within eight years. Paying off the debt in full in such a time frame was always nonsense. But with the right policies he could have at least had them go in the directions he advocated. However, they both have moved in the exact opposite direction. Furthermore, this was not only a consequence of the economic collapse this year. They were both already increasing before this year. The economic collapse this year has simply accelerated those trends – especially so in the case of the fiscal deficit.
B. The Record High Fiscal Deficit
The federal deficit hit 15.2% of GDP in FY2020 (using the recently issued September 2020 estimate by the CBO of what GDP will be in FY2020). The highest it had been before (other than during World War II) was 9.8% of GDP in FY2009, in the final year of Bush / first year of Obama, due to the economic collapse in that final year of Bush. In dollar terms, the deficit this fiscal year hit $3.1 trillion, which was not far below the entire amount collected in tax and other revenues of $3.4 trillion.
This deficit is incredibly high, which does not mean, however, that an increase this year was not warranted. The US economy collapsed due to Covid-19, but with a downturn sharper than it otherwise would have been had the administration not mismanaged the disease so badly (i.e. had it not neglected testing and follow-up measures, plus had it encouraged the use of masks and social distancing rather than treat such measures as a political statement). By neglecting such positive actions to limit the spread of Covid-19, the only alternative was to limit economic activity, whether by government policy or by personal decision (i.e. to avoid being exposed to this infectious disease by those unwilling to wear masks).
The sharp increase in government spending this year was therefore necessary. The real mistake was the neglect by this administration of measures to reduce the fiscal deficit during the period when the economy was at full employment, as it has been since 2015. Instead of the 2017 tax cut, prudent fiscal policy to manage the debt and to prepare the economy for the risk of a downturn at some point would have been to call for a tax increase under such conditions. The tax cut, coupled also with an acceleration in government spending, led fiscal deficits to grow under Trump well before Covid-19 appeared. Indeed, they grew to record high levels for periods of full employment (they have been higher during downturns). As the old saying goes: “The time to fix the roof is when the sun is shining.” Trump received from Obama an economy where jobs and GDP had been growing steadily and unemployment was just 4.7%. But instead of taking this opportunity to reduce the fiscal deficit and prepare for a possible downturn, the fiscal deficit was increased.
The result is that federal government debt (held by the public) has jumped to 102% of GDP (using the CBO estimate of GDP in FY2020):
The last time the public debt to GDP ratio had been so high was at the end of World War II. But the public debt ratio will soon certainly surpass that due to momentum, as fiscal deficits cannot be cut to zero overnight. The economy is weak, and fiscal deficits will be required for some time to restore the economy to health.
C. The US Trade Deficit is Also Hitting Record Highs in Dollar Terms
In the 2016 campaign, Trump lambasted what he considered to be an excessively high US trade deficit (specifically the deficit in goods, as the US has a surplus in the trade in services), which he asserted was destroying the economy. He asserted these were due to the various trade agreements reached over the years (by several different administrations). He would counter this by raising tariffs, on specific goods or against specific countries, and through this force countries to renegotiate the trade deals to the advantage of the US. Deficits would then, he asserted, rapidly fall. They have not. Rather, they have grown:
Trump has, indeed, launched a series of trade wars, unilaterally imposing high tariffs and threatening to make them even higher (proudly proclaiming himself “Tariff Man”). And his administration has reached a series of trade agreements, including most prominently with South Korea, Canada, Mexico, Japan, the EU, and China. But the trade deficit in goods reached $83.9 billion in August. It has never been so high. The deficit in goods and services together is not quite yet at a record high level, although it too has grown during the Trump period in office. In August that broader deficit hit $67.1 billion, a good deal higher than it ever was under Obama but still a bit less than the all-time record of a $68.3 billion deficit reached in 2006 during the Bush administration, at the height of the housing bubble.
The fundamental reason the deficits have grown despite the trade wars Trump has launched is that the size of the overall trade deficit is determined not by whatever tariffs are imposed on specific goods or on specific countries, nor even by what trade agreements have been reached, but rather by underlying macro factors. As discussed in an earlier post on this blog, the balance in foreign trade will be equal to the difference between aggregate domestic savings and aggregate domestic investment. Tariffs and trade agreements will not have a significant direct impact on those macro aggregates. Rather, tariffs applied to certain goods or to certain countries, or trade agreements reached, may lead producers and consumers to switch from whom they might import items or to whom they might export, but not the overall balance. Trade with China, for example, might be reduced by such trade wars (and indeed it was), but this then just led to shifts in imports away from China and towards such countries as Viet Nam, Cambodia, Bangladesh, and Mexico. Unless aggregate savings in the US increases or aggregate investment falls, the overall trade deficit will remain where it was.
Tariffs and trade agreements can thus lead to switches in what is traded and with whom. Tariffs are a tax, and are ultimately paid largely by American households. Purchasers may choose either to pay the higher price due to the tariff, or switch to a less desirable similar product from someone else (which had been either more expensive, pre-tariff, or less desirable due to quality or some similar issue), but unless the overall savings / investment balance in the economy is changed, the overall trade deficit will remain as it was. The only difference resulting from the trade wars is that American households will then need to pay either a higher price or buy a less desirable product.
It is understandable that Trump might not understand this. He is not an economist, and his views on trade are fundamentally mercantilist, which economists had already moved beyond over 250 years ago. But Trump’s economic advisors should have explained this to him. They have either been unwilling, or unable, to do so.
Are the growing trade deficits nevertheless a concern, as Trump asserted in 2016 (when the deficits were lower)? Actually, in themselves probably not. In the second quarter of 2020 (the most recent period where we have actual GDP figures), the trade deficit in goods reached 4.5% of GDP. While somewhat high (generally a level of 3 to 4% of GDP would be considered sustainable), the trade balance hit a substantially higher 6.4% of GDP in the last quarter of 2005 during the Bush administration. The housing bubble was then in full swing, households were borrowing against their rising home prices with refinancings or home equity loans and spending the proceeds, and aggregate household savings was low. With savings low and domestic investment moderate (not as high as a share of GDP as it had been in 2000, in the last year of Clinton, but close), the trade deficit was high. And when that housing bubble burst, the economy plunged into the then largest economic downturn since the Great Depression (largest until this year).
Thus while the trade deficit is at a record level in dollar terms (the measure Trump refers to), it is at a still high but more moderate level as a share of GDP. It is certainly not the priority right now. Recovering from the record economic slump (where GDP collapsed at an annualized rate of 31% in the second quarter of 2020) is of far greater concern. And while expectations are that GDP bounced back substantially (but only partially) in the third quarter (the initial estimate of GDP for the third quarter will be issued by the BEA on October 29, just before the election), the structural damage done to the economy from the mismanagement of the Covid-19 crisis will take substantial time to heal. Numerous firms have gone bankrupt. They and others who may survive but who have been under severe stress will not be paying back their creditors (banks and others), so financial sector balance sheets have also been severely weakened. It will take some time before the economic structure will be able to return to normal, even if a full cure for Covid-19 magically appeared tomorrow.
Trump promised he would set records. He has. But the records set are the opposite of what he promised.