Charts of the Week: Tariff Trouble

Global current account imbalances Several US economic commentators have argued that US trade imbalances are fundamentally driven by capital account dynamics rather than trade policies or unfair competition. In other words, the US runs a persistent current account deficit not because of trade flows, but because of an excess capital account surplus—meaning that the US absorbs foreign savings surpluses from economies such as China, Germany, and Japan. These countries save more than they invest domestically, and their surplus savings are recycled into US financial markets due their deep and flexible capital markets, and superior return prospects. This explains why fluctuations in Germany’s, Japan’s, and China’s current account surpluses in recent years have been mirrored by corresponding shifts in the US current account deficit (chart 1).

The US dollar As noted, this continuous inflow of foreign capital has pushed up the value of the dollar (chart 2), making US exports less competitive while encouraging domestic consumption and imports, reinforcing the trade deficit. That means that policies aimed at reducing US trade deficits via tariffs could be ineffective because they fail to address these underlying global savings and investment imbalances.

Potential growth rates As further noted, another key factor behind the global imbalances concerns the US economy’s superior growth prospects compared with elsewhere. As Chart 3 illustrates, the US has maintained slightly higher potential GDP growth over the past 10–15 years, in stark contrast to the declining potential growth rates in Germany and China (albeit from much higher levels). Meanwhile, Japan’s potential growth has remained relatively stable but at already subdued levels.

Reserve currencies Another key driver of the dollar – and the US current account deficit – is arguably the continued dominance of the US dollar in central banks’ reserves. Chart 4 below illustrates the global share of allocated foreign exchange reserves across major currencies over time. It shows that the US dollar has maintained a dominant share of these reserves, consistently accounting for over 55-60% of the total. This means that policies aimed at reducing the allure of the US dollar – and its financial markets – may find more success in reducing US trade imbalances compared with bilateral tariff policies.

Savings, investment and demographics Policies aimed at reducing savings surpluses in overseas economies could also be more effective than bilateral tariffs in addressing trade imbalances, but they are difficult to implement. Chart 5 highlights a (small) negative correlation between current account balances and dependency ratios, indicating that economies with higher dependency ratios (i.e., more children and elderly relative to the workforce) tend to have lower current account balances. This occurs because higher dependency ratios reduce national savings, as dependent populations consume more while contributing less to production and savings, leading to current account deficits. The US deficit appears broadly in line with other major economies, given its demographic structure and investment needs. However, Germany and Japan stand out as big outliers, running very large savings surpluses despite ageing populations. This is a function of several factors including their strong industrial base and a cultural aversion to debt accumulation, partly shaped by historical legacies. Policies that trigger a reduced aversion to debt and encourage greater domestic consumption and investment could help rebalance global savings and trade flows. In Germany, this could involve higher public spending, stronger wage growth, and tax incentives to boost household consumption, while in Japan, reforms to pension systems and labour markets could incentivize higher domestic investment.

Global trade and supply chain pressures Predicting how these developments will unfold and their broader impact on the global economy remains highly uncertain. The latest daily data from the Baltic Dry Index indicates that global shipping costs have fallen sharply in recent weeks, likely due to weaker demand for bulk shipping and container freight. Additionally, uncertainty surrounding trade policy may have led businesses to delay investment in global supply chains, further dampening shipping demand. However, in the longer term, higher tariffs could introduce new supply chain pressures. If tariffs provoke retaliatory trade measures from China or other key partners, logistics networks could come under renewed strain, leading to heightened supply chain volatility. This could, in turn, drive up costs, disrupt trade flows, and re-ignite global inflation risks, and add further complexity to an already fragile global economy.