WHAT’S BEHIND A TRADE DEFICIT?

By Zheng Jingping

Although there are many causes triggering the trade disputes between China and the United States， the main reason is still the huge and chronic U.S. trade deficit with China， which has long vexed the U.S. government.

The United States believes that its extraordinarily large trade deficit with China is unfair. Over the past two decades， successive U.S. administrations have raised and emphasized this issue. Under the slogans of “America First” and“fair trade，” current President Donald Trump sees the trade defi cit as the number one problem regarding economic and trade relations with China， and has demanded a substantial cut of the U.S. trade defi cit with China.

A clear understanding of the U.S. trade deficit with China will not only help fundamentally alleviate the trade disputes between the two countries， but also promote the longterm stable development of bilateral economic and trade relations. It will also help prevent the Trump administration from waving the tariff stick against its other trading partners and promote long-term stable development of international economic and trade relations.

Nature of the deficit

In both theory and practice， a trade deficit is inevitable for the United States since its currency serves as one of the main interna- tional reserve currencies. Historical data and economic and fi nancial theories have proven that countries which hold this position inevitably run a deficit in goods and service trade with other countries. Otherwise， their currencies are unable to fl ow out to serve as international reserve currencies.

That is to say， a trade deficit is almost an inevitable result for countries whose currencies are the main international reserve currencies， especially for the United States. The U.S. dollar is a dominant international reserve currency， accounting for about two thirds of the worlds total reserves. This has been substantiated by international trade data from 1958 to 2017.

When precious metals or fiat currencies based on precious metals were used as international reserve currencies under the Bretton Woods system before 1971， it was possible for the four major countries， namely， the United States， the United Kingdom， Germany and Japan， to have a trade surplus. All of these countries currencies were international reserve currencies.

But after the collapse of the Bretton Woods system in the 1970s， especially after the Jamaica Agreement took effect in 1976， the total sum of exports of countries whose currencies served as international reserve currencies was always less than the sum of their imports； that is， they accumulated a trade deficit. From 1976 to 1981， the commodity trade deficit of the big four—the United States， the U.K.， Germany and Japan—totaled $138.9 billion， averaging$23.2 billion annually. From 1982 when service trade data began to be calculated to 2016， the goods and service trade defi cit of the big four countries totaled $9.8 trillion， averaging $279.9 billion annually. The Chinese renminbi was included in the Special Drawing Rights （SDR） basket in 2016， making it the fi fth reserve currency， and this rule still applies.

The U.S. dollar is the dominant international reserve currency， making a trade defi cit all the more inevitable. In addition， the U.S. savings rate is very low. The average annual savings rate in the United States from 2001 to 2017 was only 17.7 percent， less than two fi fths of Chinas average annual savings rate of 47.2 percent for the same period. The U.S. household savings rate was sometimes below zero， making a huge trade defi cit inevitable.

The United States has a trade deficit not only with China， but also with many other countries. Unless it voluntarily gives up the U.S. dollars status as an international reserve currency， it will not run the trade surplus that President Trump is hoping for.

Some people may ask why Germany is able to maintain a trade surplus while the Deutsche Mark （DM）， later the euro， serves as an international reserve currency. The main reason is that before the euro was issued， the DMs share of international reserves was much lower than that of the U.S. dollar. For instance， in the fourth quarter of 1970， the DMs share of international reserves was 1.9 percent， while that of the U.S. dollar was 84.9 percent. In the fourth quarter of 1980， the two currencies shares were 12.9 percent and 57.9 percent， respectively. And in the fourth quarter of 1998， before the euro was established， their shares were 13.9 percent and 69.3 percent， respectively.

In addition， the overall savings rate in Germany is higher than that in the United States. For example， from 1991 to 2017， the average annual savings rate in Germany was 25 percent， while in the United States it was only 18 percent. And the difference was greater during the post-war reconstru ction and recovery period in Germany.

A trade deficit is actually a bonus for a country whose currency serves as an international reserve currency， including its consumers. The country and its people can consume and invest with borrowed money from surplus countries. This is particularly cost-effective today as the global economy faces inflation.

In addition， the United States， taking advantage of the dollars status as an international reserve currency， is able to implement loose monetary policies to help itself out of financial crises. For example， during the 2008 crisis， the U.S. Federal Reserve adopted several rounds of quantitative easing， which played an important role in getting the country out of the financial crisis.

Of course， the other side of the coin is that a country whose currency is an international reserve currency faces certain risks. Since a debt has to be repaid at some point， once there is a credit crisis， the blow to its national economy will also be substantial. The sharp decline of the Japanese economy after the 1985 Plaza Accord is a case in point.

Solutions

In order to eliminate the huge U.S. trade deficit， the United States should increase its saving rate， reduce imports， raise productivity and expand exports. Moreover， the key should be to deepen the reform of the international financial system. This is a fundamental solution to problems facing a country whose currency is an international reserve currency， in particular， a trade deficit.

In fact， after the latest worldwide financial crisis erupted， the international community has been critical of the present reserve cur- rency system. This system can cause problems such as financial crises， disputes arising from huge trade deficits and insecurity on the part of relevant countries， as well as the problem of a country holding a main international reserve currency depriving other countries through a quantitative easing monetary policy.

A consensus on reform has been initially reached. For the long-term stable development of the international economy and trade， the international reserve currency system should really be reformed.

The reform can follow two main directions. The first is to select several sovereign currencies through market competition and then form a combined international reserve currency using the weighted average method. That is， a basket of currencies or something similar to the SDR should be used as an international reserve currency.

The sovereign currencies making up the combined international reserve currency must be regulated. For example， the issuance of these sovereign currencies should be transparent， the quantity of money supply must be approved by a certain international review mechanism， or these currencies should， to a certain degree， be pegged with some precious metals.

There is no doubt that such a practice would compel these countries to surrender some sovereignty in making monetary policies. However， this will prevent these countries from abusing their money-issuing rights. This will also stop them from infringing on other countriesinterests and guard against deflation resulting from the gold standard system. When precious metals such as gold， silver， and copper or fiat currencies pegged to precious metals were used as international reserve currencies， bottle- necks in the output of precious metals often led to global deflation， hampering economic and trade development. That is the fundamental reason for the collapse of the Bretton Woods system.

As for the concrete organization that could implement the suggested policy of forming a combined international reserve currency， the international community could authorize the International Monetary Fund to do so or establish a new international organization for this purpose.

This idea not only preserves the advantages of the current system by allowing sovereign currencies to become an international reserve currency through market competition， but also overcomes the drawbacks of the existing system. This is an easier road to take rather than to create a brand new international reserve currency.

The other direction to follow is to use the latest financial science and technology， such as block chain and other innovative financial instruments to form a virtual international reserve currency， when the time is right， that can be fundamentally independent of any sovereign currency.

In short， we hope the United States can understand its huge trade deficit objectively and see the heart of the problem. It can give up the dollar as a major international reserve currency and continue to increase its savings rate and labor productivity， or it can maintain the status quo and seriously control the possible risks of its excessive dollar issuance and massive longterm debts.