The Treasury Department reported yesterday that the federal budget deficit increased 77% through the first four months of the new fiscal year (October through January) to $310 billion. Over the past twelve months, the budget deficit totaled $914 billion, which was the highest level since early 2013. This morning we learned that the US trade deficit was just about $60 billion in the month of December, 2018. The trade deficit for the full year 2018 was $621 billion, which was the highest level since early 2009. In the chart below, you will notice that the budget and trade deficits have been growing in lockstep over the past couple of years. This is notable because usually the budget and trade balances move in opposite directions.
Sources: US Census Bureau and US Department of Treasury
During periods of solid economic growth, budget deficits tend to shrink to reflect 1) a lower need for government spending to support economic growth, and 2) relatively high tax revenue from increased economic activity. Trade deficits, on the other hand, tend to rise during periods of economic expansion as 1) strong demand leads to a greater demand for imports; and 2) a strong dollar makes US exports less affordable and imports more affordable. During periods of weak economic growth or recession, the government generally increases spending to support the economy even as tax revenue falls. At the same time, demand for imports weakens and a falling dollar can often boost exports.
Back to the chart above, which shows the history of US trade and budget deficits since 1995. You will see that the two are generally negatively correlated, especially during recessions (the gray bars). Prior to the past couple of years, the last time the two moved up in unison was during the 2002-2004 period. During this time frame, budget deficits surged following two tax cuts by the Bush administration (in 2001 and 2003), which were designed to jump-start economic growth following a short recession in 2001 and the 9/11 attacks. Fortunately, economic growth did accelerate, averaging about 3% from 2002 to 2006, which was enough growth to reduce the budget deficits until the eve of the next recession in December, 2007. But look at what happened to the trade deficit during that period of strong economic growth from 2002 to 2006. The trade deficit continued to skyrocket as the strong economy boosted demand for all kinds of imports. What is even more notable is that this surge in the trade deficit came in the face of a sharp drop in the value of the dollar. On a trade-weighted basis, the dollar dropped about 15% from 2002 to 2006.
What is the lesson in all this? Historically speaking, at least, small trade deficits are more consistent with weaker economic growth and larger budget deficits. Therefore, a policy goal of minimizing trade deficits could be difficult to achieve if economic growth is to continue at current levels or even accelerate. Could revisions to trade agreements change this calculus? Sure, it’s possible. But at the end of the day, strong demand for imports is a good sign of economic vitality. And a strong dollar, which usually accompanies a strong economy, is a good thing because it reduces the price of all kinds of products produced outside the US.