The current account or trade balance, a touchy subject for the US for a long time. As usual with numerous presidents before Trump, Trump blames current account surplus countries like China, Germany and many developing countries for America’s current account deficit which Jeffrey Sachs described Here.

The main points Jeffrey Sachs raised in his article is as follows:

1. Trump says that America has a current account deficit because of unfair trade practices that China and Germany has.
2. Sachs attributes this not to trade practices by other countries as much as the low savings rate that America has.
3. Most of America’s trade deficit is due to government borrowings or spending exceeding government revenue. America’s political landscape has a heavy populism appeal with Democrats favoring increased government spending and Republicans favoring tax cuts. Both served to exacerbate government budget.

I agree to the first point to a certain extend, at least in China’s case. China has always maintained a fixed peg to the US dollar and have persistently maintain a “weak” exchange rate so that its products are cheap. But this argument is not that valid in my opinion, most of the advanced countries did the same thing in the last century. Their objective was to export everything and gather more and more gold to the maximum extent by instituting protectionist policies – AKA mercantilism.

China has this arrangement because it felt that restricting capital control, having a fixed exchange rate and an independent central bank, provided the ideal economic development environment in which to build up domestic companies and capabilities focused on the export industry since domestic demand was lacking.

As for what is Sachs is saying in point 1 and 2, it is true that savings is also the reason behind the current account deficit. Specifically, he’s referring to this mathematical identity,

National Savings – Investments = Exports – Import = Trade Balance

For an extensive derivation of the identity, please refer to the workings at the end. If not, just take it as it is. As you can see from the identity, a trade balance is determined by the net exports and net savings. A way to think about this is to assume that the trade balance is zero (balanced) which yields

National Savings = Investments

If let’s say its citizens and Government love spending and cutting taxes *cough* Americans, and its national savings decrease, this means investments decrease too. But what if there is a way to maintain investments as fixed, this requires other countries that have excess savings (China, Germany) to channel the funds to fund the deficit and it becomes

National Savings < Investments
National Savings – Investments < 0 (Deficit)

So….. isn’t this a bigger sign of the deficit problem? Americans are spending too much and have low savings, and that investment gap is actually financed by other countries whose savings rate are higher. Food for thought, eh?

Let’s start with the basics of the GDP equation,

1. Y (GDP)
   = C (consumption) + I (investment) + G (government spending) + TB (trade balance = Exports – Import)
   = Disposable Income + Net Tax RevenueY = C + I + G + ( X – M ) = Y(D) + T
2. And then, we define government savings and private savings as National Savings = Government Savings + Private Savings
   S(N) = S(G) + S(P)
   S(P) = Disposable Income – Consumption = Y(D) – C
   S(G) = Net Tax Revenue – Government Spending = T – G
3. Substituting Y = Y(D) + T into the basic equation and rearranging them, we will get
   Y – C – I – G = X – M = TB
   Y(D) – C + T – G – I = TBSubstituting Y(D) – C = S(P) and T – G = S(G) will yield
   S(P) + S(G) – I = TB
   S(N) – I = TB

Yes, in the end, Savings – Investments is equivalent to the trade balance too. When savings exceed investments, there will be a current account surplus and when investments exceed savings, there will be a current account deficit.

Post Photo from MightyTravel