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In this issue, we’re tracing the journey of the U.S. trade deficit. We’ll uncover the policies, decisions, and partnerships that played a major role in shaping it. Plus, we’ll tackle the big questions: what’s driving the U.S. trade deficit, and is having a trade deficit necessarily a bad thing? Let’s dive in!

The Great American Trade Problem 💰

"They’re stealing from us, and it’s time we stop them." Donald Trump’s fiery words on trade deficits hit a nerve — and he’s not entirely wrong. With $279 billion with China, $152 billion with Mexico, and $202 billion with the EU, these trade deficit numbers are hard to ignore. 

But here’s the twist: it wasn’t always like this. America was once a global trade champion, running surpluses and leading the world in exports. So, what changed? To find out, let’s rewind the clock and uncover the economic policies and global events that transformed the U.S. from a trade surplus nation to a deficit-driven economy.

Good Times

When the Second World War ended in 1945, much of the world grappled with shattered economies. However, in the United States, a very different story was unfolding. The country emerged from the war with robust industrial and manufacturing machinery and a workforce skilled in large-scale production.

Soon, American factories, fine-tuned for wartime manufacturing, quickly transitioned to producing consumer goods at an unprecedented pace. The post-war period was a time of remarkable economic expansion for the United States. American exports soared as nations in Europe and Asia relied heavily on U.S. products to reconstruct their economies. The demand for machinery, vehicles, and everyday consumer items fueled a period of sustained growth, solidifying the country’s position as a global economic leader.

This dominance was reflected in America’s trade balance. In 1947, the United States achieved a trade surplus of nearly $10 billion — a massive number for the time — amounting to over 5% of its GDP. 

In fact, throughout the 1950s and 1960s, the United States cemented its status as an industrial powerhouse. Industries like steel, automotive, and electronics thrived, driving domestic prosperity and maintaining the country’s trade advantage. By 1960, U.S. exports had reached $19.6 billion, far outpacing imports of $14.7 billion and leaving a robust trade surplus of $4.9 billion. 

If a robust industrial and labor force supercharged U.S. trade on one side, the other side was shaped by strategic trade agreements. In 1947, the United States spearheaded the creation of the General Agreement on Tariffs and Trade (GATT), a framework designed to lower tariffs and dismantle trade barriers. By championing free trade, the U.S. ensured its goods could reach markets around the world, fueling the growth of its industries and solidifying its economic dominance.

Adding to this strategic advantage was the Bretton Woods Agreement of 1944, which positioned the U.S. dollar at the center of the global monetary system. Under this system, major currencies – 44 countries were part of it – were pegged to the dollar, which in turn was tied to gold at a fixed rate. This arrangement stabilized international trade and elevated the dollar to the status of the world’s reserve currency. Countries across the globe sought U.S. dollars for trade and reserves, further increasing demand for American goods and strengthening exports.

So, how did the US economy that enjoyed a trade surplus become a trade deficit? Let’s break that down for you. 

Start of the Deficit

The U.S. trade deficit first emerged in the mid-1970s, marking a major shift in how the American economy interacted with the world. Before this, the U.S. had generally exported more than it imported, maintaining a steady trade surplus. But then, a mix of global events and changing domestic realities began to tilt the scales.

Around the same time, the rules of the global economy were changing. In 1971, the U.S. abandoned the Bretton Woods system, which had tied the dollar to gold. At first, this shift to floating exchange rates gave U.S. exports a boost, as a weaker dollar made American goods cheaper abroad. But by the late 1970s, the dollar began to strengthen, reversing that advantage. A stronger dollar made imports cheaper and U.S. exports more expensive, opening the floodgates for foreign goods.

Global competition also ramped up. By the late 1970s, countries like Japan and Germany had become leaders in manufacturing producing cars, electronics, and machinery that were high-quality and affordable. Japanese automakers like Toyota and Honda captured nearly 20% of the U.S. car market by 1980, and brands like Sony dominated American homes with their electronics. 

In the 1980s, these challenges deepened. To fight inflation, the Federal Reserve, under Paul Volcker, raised interest rates, strengthening the dollar. This made U.S. exports even more expensive abroad and imports even cheaper at home. By 1985, the U.S. trade deficit hit a record $122 billion, with nearly $50 billion of that tied to imports from Japan. 

This was also the time when American consumer habits were changing. People wanted affordable, high-quality goods, and imports from Japan, Germany, and other countries fit the bill. American retailers leaned into this demand, offering a growing selection of low-cost imported products. The result? A cultural shift that normalized the preference for imports and further increased the trade deficit.

However, the 1990s brought the biggest shift in the U.S. trade deficit, thanks to growing trade with China and Mexico. These two countries quickly became America’s top trading partners, reshaping the US trade. 

Tale of three countries 

The story of the U.S. trade deficit is incomplete without Mexico and China. These two nations have played a pivotal role in shaping America’s trade imbalance. 

Ironically, it was two trade agreements — the North Atlantic Free Trade Agreement (NAFTA) with Mexico and China’s entry into the World Trade Organization (WTO) — that opened the doors for deeper trade ties and, in the process, significantly widened the U.S. trade deficit.

After its economic reforms in 1978, China embraced global trade, attracting foreign investments with its promise of low-cost labor and vast industrial capacity. The U.S., seeing an opportunity, strengthened this relationship by granting China permanent normal trade relation (PNTE) status in 2000. A year later, China joined the WTO, a move that would, in the future, make it a global manufacturing superpower. 

To increase their profit margins, American businesses began to offshore their production to China, leveraging their cheap labor and efficient manufacturing systems. Consumer goods like electronics, clothing, and toys from China flooded the U.S. market, reshaping how Americans shopped. By 2001, the trade deficit with China was already at $83 billion, and it climbed to $418 billion by 2018 as imports from China surged. 

Yes, the offshoring did offer reduced costs for average Americans, but the nation was paying the price elsewhere. The Chinese imports and offshoring of production caused a decline in domestic manufacturing and jobs related to it. From 2000 to 2010, the U.S. lost about one-third of its manufacturing jobs, totaling approximately 5.5 million jobs during this decade alone. 

Meanwhile, closer to home, Mexico’s role in the U.S. trade story gained prominence with the signing of NAFTA in 1994. This agreement eliminated tariffs on goods traded across the U.S., Canada, and Mexico, creating a tightly integrated North American market. 

Before NAFTA, the U.S. had a $1.7 billion trade surplus with Mexico, but the agreement set in motion a shift. By the mid-1990s, this surplus had become a deficit as U.S. companies increasingly moved production south of the border. Mexico’s geographical proximity, combined with significantly lower labor costs, made it a favored destination for manufacturing. 

Under this new arrangement, industries like automotive and electronics thrived. By the 2010s, nearly 30% of U.S. imports from Mexico came from the automotive sector alone, with cars and auto parts flowing across the border to meet American demand. 

A 2017 Congressional Research Service report on NAFTA states that U.S. auto exports to Mexico increased 262% while imports increased 765% between 1993 and 2016 – clearly understating the trade deficit. 

These deficits weren’t isolated numbers. They reflected a growing trade imbalance. By the 2010s, China alone accounted for over 40% of the U.S. trade deficit in goods. Mexico, too, played a significant role as its share of the deficit steadily climbed. 

The end result: The US’s goods and services deficit reached a whopping $948.1 billion, its largest total on record, in 2022. 

What’s behind the U.S. trade deficit?

So, what products are driving these persistent and higher trade deficits? The answer lies in a handful of key categories highlighting America’s reliance on global supply chains and its insatiable consumer demand.

Let’s start with our everyday items — electronics, clothing, and household goods. These products dominate imports, pouring in from countries like China and Mexico to meet the demand for affordable and diverse options. In 2022, consumer goods significantly pushed the overall trade deficit to a whopping $948 billion, marking a 13.15% increase from 2021.

Then there’s energy. Despite years of focus on energy independence, the U.S. still imports massive amounts of crude oil and petroleum products. In 2020, crude oil imports alone accounted for a $50.2 billion chunk of the trade deficit, with other petroleum products adding another $16.5 billion.

The automotive sector is another big contributor to the deficit. Cars, parts, and engines — core to the U.S. economy— rank high on the list of deficit drivers. In 2020, passenger cars added $33.4 billion to the gap. This isn’t just about cars; capital goods like machinery and equipment also contribute. Aircraft engines alone accounted for an $11.1 billion shortfall.

The trade deficit has been a long-standing economic issue; however, it became public discourse during the presidency of Donald Trump. 

Trump times

Donald Trump has been talking about the U.S. trade deficit for decades, long before he got into politics. In October 1987, just days after the stock market crash, a 41-year-old Trump stood in front of 500 people at a Rotary Club meeting in Portsmouth, New Hampshire. 

During his speech, Trump didn’t hold back. He called out Japan, Saudi Arabia, and Kuwait, accusing them of taking advantage of the U.S. “We should have these countries that are ripping us off pay off the $200 billion deficit,” he said, arguing that fixing the federal deficit shouldn’t mean higher taxes for Americans. It was one of the first glimpses of Trump’s fiery take on trade and economic issues — a theme that would become central to his political career years later.

Three decades after this speech, Donald Trump, after winning the 2017 presidential race, set out to address the growing trade deficit with China — $346 billion at that time — with a weapon he loved the most: tariffs. 

The rationale was clear: these tariffs were meant to reduce America’s reliance on Chinese imports and level the playing field for U.S. industries. Trump framed them as a necessary step to protect American workers and rebuild the nation’s manufacturing base.

Did Trump’s tariffs work?

Yes, Trump’s tariffs temporarily reduced the trade deficit with China. When the tariffs were introduced in 2018, the deficit decreased from $375 billion in 2017 to $344 billion in 2018. By 2020, it further declined to $310.8 billion. These figures marked a short-term reduction, largely driven by decreased imports from China as companies sought to avoid tariffs.

However, according to experts, this reduction was not entirely due to the effectiveness of the tariffs. The decline in imports from China was accompanied by a shift in supply chains to other countries like Vietnam, India, and Mexico.

Additionally, the cooling of the U.S. economy in 2019 and the pandemic-induced economic slowdown in 2020 also played a role in reducing import volumes.

Are US trade deficits good or bad?

Economists remain divided on whether U.S. trade deficits are beneficial or harmful, with the answer often depending on the broader context and the lens through which the issue is examined.

On the positive side, trade deficits can indicate strong domestic demand and a robust economy. The U.S. imports a significant volume of goods, which reflects the purchasing power of its consumers and businesses. Economists like Paul Krugman argue that trade deficits are not inherently negative but are a natural result of a consumption-driven economy that benefits from access to cheaper imports.

Additionally, the U.S. trade deficit is partly offset by a surplus in services, including technology, finance, and intellectual property, where the U.S. has a competitive advantage. 

However, some economists point out that persistent trade deficits, particularly in goods, often correlate with the decline of domestic manufacturing and job losses in key industries. Furthermore, overreliance on imports can create vulnerabilities, especially in critical supply chains, as highlighted during the COVID-19 pandemic, when global disruptions impacted the availability of essential goods.

Conclusion

Trade deficits are making waves again, especially with Donald Trump back in office. This time, he’s not just targeting China—he’s eyeing tariffs on goods from some of America’s closest trade partners, like Mexico, Canada, and the European Union.

Sure, economists say trade deficits aren’t always a bad thing. They reflect strong consumer demand and the buying power of Americans. But let’s face it — those deficits also mean factories shutting down and jobs disappearing. America has always been a champion of free trade, but there’s a fine line. Trade is great, but not when it comes at the expense of American industries, jobs, and workers.

This newsletter was written by Shyam Gowtham

Thank you for reading. We’ll see you at the next edition!