Buy American, Hire American, Balance the Budget

Mercantilism was popular from the 16^th to 18^th centuries. It is the belief that a government policy which encouraged and promoted exports while simultaneously restricting imports had a positive effect on the economy. This trade imbalance would result in an accumulation of gold by the exporting country making it wealthier. Today, we could call it “Trumponomics” or perhaps “alt-econ”, as this is what the US President seems to be promoting.

The key assumption underlying Mercantilism is that the world’s wealth is static. The implication is that domestic growth comes at the cost of a country’s trading partners. That assumption may have been valid prior to the Industrial Revolution but certainly not now.

A trade surplus is no longer a viable source of growth because the assumption that wealth is static is no longer valid. With the exception of a few hiccups along the way, the economies of the industrialized countries have been growing since the late 19^th century.  In addition, national governments have embraced the ideology of John Maynard Keynes and, since the Great Depression of the 1930’s, have borrowed money to stimulate economic activity and control unemployment. The following example helps to illustrate what happens when a government runs a deficit in an open economy.

Suppose that the US imports $600 billion of goods and services from China and it exports $500 billion of goods and services to China. The net amount of $100 billion is what the US must pay to China in some form or other.  A wire transfer of 100 billion US dollars to Beijing would be the easiest solution.  What would China do with this money?  They have already purchased all the US-made goods that they desire, so now they must purchase US assets. This may be real estate in the US, shares in US companies, or perhaps United States Treasury Bonds.  Of the three choices, the “Treasuries” are the most secure.  Therefore, the safest choice for China is to take the $100 billion and buy US Government bonds.  These bonds are created when the federal government runs a budget deficit.  Expenditures exceed tax revenues and the government must borrow the rest.  The US runs a trade deficit of about $43 billion per month and a budget deficit of about $50 billion per month.  Note the similarity between these numbers, and relationship between the two graphs below which show the US Balance of Trade, and the Federal Debt.

If the US government wishes to have balanced trade, they must also balance their budget. The only other ways to fund the budget deficit, other than a trade deficit, are for: a) households to increase their savings by $50 billion per month – reducing consumer spending by $50 billion per month, or b) monetize the budget deficit – have the Treasury issue $50 billion of debt to the Federal Reserve in exchange for newly ‘printed’ money. Unfortunately for the President, the Fed increased their bond holdings dramatically after the financial crisis of 2008 and has recently announced that they will be reducing their bond holdings effective October of this year. Unfortunately for Mr. Trump, there is no presidential order that can change the laws of economics.