Why global imbalances do matter

NOBODY can know either the future course of the new war in the Middle East or its possible economic effects. I wrote what I could on this in a column entitled The Economic Consequences of the Israel-Hamas War, on Oct 31, 2023. The big question, I argued, was whether the conflagration would extend to oil-related production and transport from the Gulf region. This region contains 48 per cent of global proved reserves and produced 33 per cent of the world’s oil in 2022. It also has a chokepoint on exports at the Strait of Hormuz. These realities remain. The question is now mostly about Donald Trump: Does he know how to end this war?

It is a question raised in other areas, too, notably the interaction of his trade policy with his fiscal policy. The aim of the former is to reduce, if not eliminate, trade deficits. The aim of the latter is to run huge fiscal deficits. These two objectives are incompatible. Large external deficits mean, by definition, that the country is spending more than its income. Since the US economy is running close to its potential, with an unemployment rate at only 4.2 per cent, no quick way to raise incomes further exists. So reducing the external deficit will require reductions in national spending.

The obvious way to do this would be with a sustained lowering of the fiscal deficit, via higher taxes and lower spending commitments. That would allow the Federal Reserve to lower interest rates, which Trump would welcome. It should also weaken the dollar, which should help increase production of tradeable goods and services. So, apart from the fact that Trump adores low taxes and high spending, why not go for this?