Unpacking Global Fiscal and Trade Imbalances

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Text on screen: Ken Chambers, Fixed Income Strategist

Ken Chambers: Global uncertainty, U.S. exceptionalism coming under question. And really this shift in priorities towards national interests. What were some of the discussion points?

Tiffany Wilding: Yeah. So clearly, we have a new potential disruptor.

Text on screen: Tiffany Wilding, Economist

And we would argue these various policy pivots, all kind of come back to the interconnected issue of global trade imbalances.

B-roll: Shipping, auto manufacturing, lumber

What the administration would argue is that efficient market mechanisms should effectively balance trade over time. So an example of that is if you have a country that has a competitive advantage in some product or service, they'll export, they have an initial trade surplus.

But as a result of that, they also are getting higher domestic incomes from all of those profits coming back into the country and they consume more. And as they consume more, they import more things. You probably also have a currency adjustment and appreciation that's happening. And over time that helps rebalance trade. So you effectively are exporting to import.

FULL PAGE GRAPHIC TITLE – Difficult Structural Reforms Needed and Changes Require Large Fiscal Policy Adjustments. The subtitle is Trade balance versus fiscal balance (% of GDP). The chart measures eight countries’ Fiscal balance as a share of gross domestic product, or GDP on the Y-axis on the left and Trade balance as a share of GDP on the X-axis at the bottom. From the left shows four countries with negative fiscal and trade balances: the United States with approximately -4.1% fiscal balance and -2.9% trade balance; the United Kingdom with approximately -3.5% fiscal balance and -1.2% trade balance; France with approximately -3.1% fiscal balance and -1.1% trade balance; and Brazil with approximately -0.8% fiscal balance and -0.2% trade balance. The right side of the chart shows two countries with negative fiscal balances and positive trade balances: China with approximately -3.6% fiscal balance and 2.4% trade balance; and Vietnam with -2.6% fiscal balance and 2.2% trade balance. Korea and Germany show positive fiscal and trade balances. Korea’s fiscal balance is approximately 0.1% and its trade balance is approximately 3.3%. Germany’s fiscal balance is approximately 0.5% while its trade balance is approximately 5.5%. The footnotes at the bottom left corner of the chart reads as of December 2024; Source: World Bank, IMF, Haver, and PIMCO.

But if you look at the last 40 years of trade within the global economy, what you see is that mechanism clearly has not happened. So we have countries that have effectively run serial trade surpluses China, Japan, maybe before the pandemic, also places like Germany, Korea, Singapore against other countries in the global economy that run serial trade deficits, that's the United States. But also, you have countries like the UK and France that do as well.

So there's a key question around why is that happening, why are we not getting that rebalancing? And the administration would argue it's because of policies, regulatory, other sort of structural policies within these trade surplus countries that effectively depress consumption. They require their household sector to subsidize manufacturing. And so, the result of that has been places that don't do that like the United States, they can't compete. And we've had a hollowing out of the middle class. We've had a reduction in manufacturing share in the United States because we can't compete with this. As a result of how the government's social safety net is set up, that's resulted in automatic stabilizer type of programs that have increased the US federal fiscal deficit. So things like Medicare, food assistance programs, US disability programs, all have had increased pickup as a result of what economists call this a China shock.

So, as you can see as I'm talking, these are structural issues that require structural adjustments that will be difficult. And I think that just puts in perspective the broader discussion that's happening in Washington around really cutting federal government spending and fiscal deficits.

B-roll: The Federal Reserve, grocery store aisle and checkout, automobile gas pump

So all of this is to say is that the fed has some tricky decisions that they're going to make, we think it really will boil down to our recession risks rising faster than inflation risks. And on this point, I would say that there has been recently a very uncomfortable increase in inflation expectations across the various consumer surveys and business surveys more recently, and this could eventually constrain the fed. It's obviously going in the direction they don't want it to go. We think what it means is the more preemptive cuts that the fed did in 2018, 2019, for example, against potential weakness, they could be more constrained in that. But nevertheless, if they're seeing the unemployment rate increase, we think they're cutting aggressively as those recession risks are increasing.

But the US is not the only place that needs to make these adjustments. Elsewhere like China, other places also need to make those adjustments. The US is trying to force that through higher tariffs. That's creating some disruption. And it's really yet to be seen how much additional price level adjustment, how much additional market volatility the US voter base is willing to tolerate to get through this period. So I think all of this is to say, is that these structural adjustments, they have important constraints. And that's just creating a lot of near-term uncertainty.

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