There are some early signs that the incoming U.S. administration will pay more attention to the part of its economy that accounts for one-third of demand and output.

In a recent discussion with the Canadian prime minister, President-elect Trump raised the question of Washington’s large and systematic trade deficits with its North American neighbors. What might have come to his attention is a U.S. trade gap widening 8.4% in the first ten months of this year to a hefty total of $192.3 billion.

And in a friendly banter Trump suggested that Canada and Mexico might as well become part of the U.S. if they wished to continue receiving such big “subsidies.”

Otherwise, he said that Canada and Mexico would face an import tariff of 25% unless they squared their trade accounts with Washington and stemmed the flow of migrants and drugs into the U.S.

Huge trade deficits with E.U. and China

That could be taken as a light-hearted dinner conversation with Canadian friends during the Thanksgiving weekend, but that was also a signal of policy intent to the E.U. and China. Indeed, those two large economies account for half of the total U.S. trade deficit.

America’s trade partners should take that seriously. A large clean-up and restoration job is ahead for an economy whose growth is suppressed by trade deficits and undermined by a public debt of $36 trillion, budget deficits of 8% of GDP and net foreign liabilities of $22.5 trillion -- rising at a quarterly rate of $1.23 trillion.

The E.U. and China will have to substantially adjust their trade relations with the U.S.

With a growth rate of 0.6% in the first three quarters of this year, stagnation and shrinking domestic demand in the E.U. are forcing local companies to export in order to survive. Under those circumstances, regulatory obstacles to access U.S. markets will be a heavy blow, because the U.S. takes 20% of all E.U. exports.

The trans-Atlantic trade relations will get worse in the months ahead. Germany is in a deepening recession and a political turmoil in the run-up to next February’s anticipated elections. France is teetering on the edge of economic downturn, struggling with a fiscal crisis, dysfunctional government and expectations of anticipated presidential elections.

And those two countries, accounting for nearly half of the E.U. economy, cannot be rescued with lower interest rates because the European Central Bank is tied down by rising labor costs (5.1%), core inflation of 2.7% and a service sector inflation of 4%.

The pressure in the E.U. to export its way out of a deep trouble will be overwhelming. And that will be happening at a time of growing trade, political and security frictions with the new U.S. government acting in big power politics for peace in Europe, Middle East and East Asia.

Don’t slap tariffs, negotiate trade imbalances

China will find it much easier to handle more restrictive trade relations with the U.S. Beijing has a more diversified foreign trade business, and its broad economic stimulus will focus on a stronger revival of domestic demand.

Trade with the U.S. is only 11% of China’s foreign trade, while more than half of Beijing’s trade business is transacted with its captive markets in Asia, ten BRICS countries and the rest of the Global South.

China can also absorb declining exports by revving up household consumption, residential and business investments. Expansionary monetary policy is an obvious instrument to unlock demand in those large GDP components.

The declining inflation offers plenty of room to do that. Consumer prices in November slowed down to an annual rate of 0.2% from a recent peak of 0.6% in August. However, oddly enough, Chinese monetary authorities are concluding that an easing policy would create speculative bubbles. That might be possible in particular regions or segments of the economy, but those problems are dealt with fiscal and regulatory adjustments rather than with the general instruments of monetary policy.

Also, a long overdue reform of China’s welfare system should lower the households’ costs for healthcare and education, leaving more income for discretionary private spending.

China, therefore, can offset the loss of some export income from the U.S. But restricted trade and investments with the U.S. would still have a negative impact on China’s economy because they would curtail access to best practice technologies and to global systems of financial intermediation.

The best way to approach the problem of a substantially unbalanced U.S.-China trade would be to negotiate a correction of bilateral trade flows without recourse to tariffs. That would put aside a highly contentious issue and open the way to a cooperative search for peace in Europe, Middle East and East Asia.