U.S. trade problems are an old story with deep roots in the international monetary system where America, serving as a banker to the world, allegedly got addicted to “deficits without tears.“

The French pinned that original “sin” to the United Nations Monetary and Financial Conference in Bretton Woods, during July 1- 22, 1944.

That’s when delegates from 44 countries agreed on an international monetary system based on fixed but adjustable exchange rates in terms of the dollar, with symmetric obligations for deficit and surplus countries to maintain balanced external accounts.

The dollar became the pillar of the international monetary system, the world’s key transactions currency and a dominant reserve asset. The U.S. followed up by agreeing to unconditionally redeem foreign dollar holdings at a price of $35 for an ounce of fine gold.

America’s “exorbitant privilege”

Led by the French, the Europeans concluded in 1950s that the U.S. was “bankrupt,” claiming that the world’s outstanding dollar holdings exceeded the value of American gold reserves. As a result, they advocated a widely rejected return to the gold standard instead of the Bretton Woods gold-exchange standard.

Undeterred, and arguing that the U.S. enjoyed an “exorbitant privilege” of being able to pay foreign trade bills in its own currency, the French moved to convert their dollar holdings into gold.

The Bretton Woods system was effectively dead in 1960s but kept going on central banks’ life support until August 15, 1971, when President Nixon closed the U.S. gold window, ushering in the era of floating exchange rates.

The dollar fell sharply, but its share of world currency reserves remained at 85%. Subsequently, however, U.S. inflation and rising trade deficits continued to erode the role of the dollar as a store of value. The latest estimate put the world’s dollar reserves at 57.8%.

In contrast, an apparently irreplaceable dollar remains the key global transactions currency, accounting for 90% of all foreign exchange trades. That lack of dollar alternatives has led to arguments of Washington’s “benign neglect” of its currency and, by extension, of American foreign trade deficits.

Even during President Trump’s first term, China, E.U. and North America (Canada and Mexico) pocketed surpluses on their U.S. trades of $1.5 trillion, $683 billion and $445.2 billion, respectively. And those are America’s largest trade partners -- accounting for 75% of the country’s merchandise trade deficit.

It appeared as if those deficits were looked upon with equanimity despite being deductions from American GDP and additions to U.S. net foreign liabilities -- $26.3 trillion at the end of last year and growing at an alarming annual rate of $6.4 trillion.

Quiet diplomacy would go further

That complacency was also masking the fact that American foreign trade deficits were caused by its low savings rate – showing an annual average of 4.1% over the last three years.

Here is how the savings argument works out. Last year, the U.S. deficit on goods and services transactions with abroad (aka, the current account of the balance of payments) came in at $1,133.6 billion. To make the ends meet, the U.S. had to finance that deficit by issuing bonds in exchange for foreign saving (i.e., foreign capital).

That is so because the balance of payments has to balance: the sum of current and capital accounts must equal to zero.

The conclusion here is that U.S. trade deficits are mainly caused by structural problems, owing to the global demand for dollar assets and America’s low savings rate. The cyclical part of the trade deficit is the strength of American domestic demand, because that determines the volume of imports of foreign goods and services.

Does that mean that raising the U.S. trade tariffs was not necessary? The answer is – Yes.

Three quarters of deficits are caused in trade relations with Canada, China, E.U. and Mexico. Quiet diplomacy – instead of coercive and counterproductive measures – could have significantly narrowed American trade gaps with those countries.

Instead of that, Washington’s demands not to retaliate was a humiliating treatment of sovereign nations. As a result, all of them – Canada, China, E.U. and Mexico – intend to retaliate. China and Canada have already done that.

Expectations that trade tariffs will lead to more production of goods and services in the U.S. are plausible, but they are also highly speculative.

And so are anticipations that the tariff income will help to pay off national debt. The tariffs net income effect depends on their inflation impact, because inflation will determine the extent to which the monetary authorities can support economic growth.

A sustained reduction of budget deficits is the only way to stop, and reverse, the growth of national debt. With a budget deficit of 8% of GDP, there is a long way to go down that road. And a high degree of prolonged fiscal restraint would need to be offset by monetary easing to avoid a recession of ex ante unknowable amplitude and duration.