The US trade deficit trap. How it got so big, why it persists, and to do about it
The United States experienced episodes of increased trade deficits from the 1970s through the 1990s, but in the first decade of the twenty-first century the U.S. trade deficit reached truly prodigious proportions never before seen in American economic history. By 2006, the trade deficit climbed to about $800 billion dollars, representing roughly 6% of the gross domestic product (GDP) at that time (see Figure 1). This meant that the United States had to borrow an equivalent amount from other nations to finance the excess of its imports over its exports, thereby increasing the nation’s net debt position with the rest of the world (which rose to $2.4 trillion at the end of 2007). The results were a significant loss of good-paying industrial jobs and a depressing effect on workers’ wages and middle-class living standards in the U.S. domestic economy.
Although the trade deficit has moderated slightly in the past two years, coming down to “only” about $700 billion or 5% of GDP in 2008, it has remained at a historically high level in spite of massive gyrations in the variables that are supposed to determine it during the past several years. The dollar fell for six years from early 2002 to early 2008, before recovering partly in late 2008; the price of oil soared up to mid-2008 and then collapsed in late 2008; and the U.S. economy went through an economic boom largely led by the housing bubble followed by a severe recession mainly induced by the collapse of that bubble and the consequent financial crisis. Yet, through all of these changes, the trade deficit has risen to and remained at unprecedented heights, and—in spite of the worst financial crisis since 1929—the willingness of foreigners to lend the United States upwards of $700 billion a year to finance this deficit has not yet abated.
Taking a longer historical view, it is clear that—in spite of large cyclical swings—the U.S. trade deficit has trended downward during the entire period since the abandonment of the Bretton Woods system of fixed exchange rates and capital controls in 1973. Contrary to what was predicted by the advocates of flexible exchange rates and financial market deregulation (e.g., Friedman, 1953), floating rates and financial liberalization have led to greater, not smaller, global trade imbalances (see Eatwell and Taylor, 2000).