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I am trying to understand the causes and macroeconomic implications of running a trade deficit in the United States, and I came across a few different views on this topic. I'd like to know if there are studies that try to understand the root-cause of this trade deficit.

First, I understand that trade deficits aren't necessarily a bad thing, and it all depends on the context. Since the trade deficit reflects the difference between savings and investment, whether it's good/bad depends on what the excess investment is being used for, and whether the investments will reap benefits in the future.

That said, my focus is on trying to understand what is causing the current trade deficit to increase; I see there are different views:

  1. US is consumption driven, and our consumers/government are spending beyond their means. That is, there is a huge demand from the US economy, which is causing us to import more than we export, which is causing the deficit. If we cut that spending, it will reduce the trade deficit [1].

  2. East Asian countries (especially China) are experiencing a "saving glut" and instead of investing in their own country, they are exporting their capital to the US and parking it in safe US-Treasury investments. It is this capital inflow to the US that is widening the trade deficit [2,3].

[1] https://www.washingtonpost.com/opinions/everything-you-need-to-know-about-trade-economics-in-70-words/2017/05/05/a2b76a02-2f80-11e7-9dec-764dc781686f_story.html?noredirect=on

[2] https://carnegieendowment.org/chinafinancialmarkets/77009

[3] https://www.federalreserve.gov/boarddocs/speeches/2005/200503102/default.htm

Qualitative evidence for (1):

Qualitative evidence for (2):

  • China is a net exporter, and continues to be competitive by taking steps to prevent RMB from strengthening against the dollar.

  • Savings rate in China is a high fraction of their GDP, relative to the US: https://tradingeconomics.com/china/personal-savings.

  • The interest rates in the US are historically low, which is because there is a lot of demand for US treasury from abroad. Quoting from [2]:

Interest rates suggest very strongly that capital isn’t sucked into the United States from abroad, but rather is pushed into the United States from abroad.

I see a bit of truth in both sides of the story. US is consumption driven (not necessarily a bad thing), and China has high savings, probably because of a host of factors such as culture (savings minded), more income inequality (rich save more of their income than the poor), etc.

I have two main questions:

  • What is the direction of causality? Is US consumption driving the trade deficit, or is foreign capital inflow driving US consumption? I'd appreciate any academic citations that argues one way or another quantitatively.

  • If it's capital inflow driving US consumption, then why doesn't US just use the cheap loans to repay its current debt? Isn't it in US's control to decide what to do with the capital we get -- why spend it?

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