Foreign Trade, tariffs, Dollar dominance and some helpful national income identities

 The brilliant Maurice Obstfeld has a very good explainer on  The U.S. Trade Deficit: Myths and Realities, Brookings Conference, March 2025.  Here's some useful national income identities

1. in nominal terms

NX=Y-(C+I+G)

where Y is nominal GDP.  This says NX = total output -(domestic absorption)

Implications 

a. NX might "due" to C that's "too high". but it might be due to I that's "too high" i.e. lots of promising investment projects. 

2. Now, define national income NOT as GDP but as GDP plus "net income from the net internatioal investment position".  Define as well national saving as national income (NOT GDP), less consumption.   Thus National income  = Savings S minus I =

Y+(RA-1)A-(RL-1)L 

where A denotes gross claims on foreigners (including banking claims, debt and equity securities, and direct investments) offering a gross interest and dividend yield (that is, not including capital gains) of  𝑅𝑅𝐴𝐴 and L gross liabilities to foreigners offering the yield 𝑅𝑅𝐿𝐿 to nonresident holders. 

Then the current account is 

CA balance=NX +(RA-1)A-(RL-1)L =S-I

3.  Now, let's drill into those returns.  National accounts does not include capital gains on assets as productive activity.  Thus the returns above are excluding capital gains.  Define then  total gross returns 𝑅𝑅~𝐴𝐴 ≡ 𝑅𝑅𝐴𝐴 + 𝐶𝐶𝐺𝐺𝐴𝐴 and 𝑅𝑅~𝐿𝐿 ≡ 𝑅𝑅𝐿𝐿 +𝐶𝐶𝐺𝐺𝐿𝐿.

Then we have 

 Then equation (2) implies that the level of net external assets A − 𝐿, also referred to as the net international investment position (NIIP), follows the process 𝐶 

A𝑡+1 −𝐿t+1 = 𝑁𝑋𝑡 +𝑅A~𝑡𝐴𝑡 −𝑅L�𝑡 𝐿𝑡.

which can be written 

4. what about "exorbitant privilege"? This is when a country can pay less out on its external liabilities i.e. what it owes to the world, than it earns on its external assets i.e. what it earns from the world which is R~L<R~A.  So the last term is positive which means that even with an unchanging A-L, the net exports can be negative. 

From that we have

1. An exchange rate depreciation that lowers M (imports) has to have something else change. It might be that X simply falls too (this is the Lerner point in a non-monetary economy, with M less to try to encorage more Y, then  X has to fall to get resources into domestic output Y). in a monetary economy, tariff means expansion of domestic demand, but interest rates rise, raising the ER until Y back to its former level.

2. The China "shock" was a shock rise in China imports. But since other countries could switch to China it was also a fall in US exports.

3. It is argued "that the U.S. dollar is the world’s overwhelmingly dominant reserve, invoicing, vehicle, anchor, and funding currency....One [theory] asserts that countries can gain the dollar reserves they wish to hold only by running external surpluses with the United States. In turn, as the world economy grows, growing reserve demand obliges the United States to run persistent deficits. A second class of theories focuses on asset-price effects that contribute to U.S. deficits. One of these contends that global dollar demand causes a chronically overvalued dollar. A related claim is that the dollar’s status allows the United States to borrow more cheaply abroad, creating a structural deficit."

Obstfeld says: The idea that the global demand for dollar assets can be satisfied only through U.S. current account deficits is widespread but wrong. The world could alternatively acquire those dollar assets in exchange for other assets rather than goods and services.  

Further "Stephen Miran has set out a “blueprint for restructuring the global trading system” built on a central premise that the dollar’s status will inevitably lead to growing and ultimately unsustainable current account and trade deficits. He calls this a “Triffin dilemma”".

It turns out that US reserves as a share of USGDP are falling not rising. 

Also, says Obsfelt " Moreover, the dollar’s global role – which confers aggregate gains on the United States – derives not only from preferences and needs that foreigners impose on a passive America, but from institutions of U.S. origin (such as a consistent rule of law, independent monetary policy, and deep, open financial markets) that also underpin American prosperity.  "