Global investors spent much of 2024 fretting over China’s troubles with a property crisis and deflation. In the year ahead, it’s America’s turn on the hot seat.
Though Donald Trump’s trade war is getting the headlines, it’s the gaping disconnect between US net foreign investment versus federal debt that’s fast coming to a head.
And forcing the incoming Treasury Department team to devise a plan to stabilize US finances, lest the globe’s biggest economy pay a high price from both investors and credit rating agencies.
Until now, Washington has been able to avoid a reckoning — and live wildly beyond its means. Yet that current account imbalance may become harder to finance during the Trump 2.0 era.
One reason is that Washington’s chronic complacency is catching up with it. The bill for President Biden’s post-Covid-19 borrowing binge to juice consumption is coming due just as foreigners show less appetite for US assets. Another is the risk emanating from Trump’s planned supersized tariffs.
These two dynamics are about to collide in spectacular and unpredictable ways — and at a moment when the buyers of US national debt are reluctant to increase exposure to a shaky US dollar.
As Biden prepares to pass the baton back to President-elect Trump, he leaves the incoming administration with a US national debt topping US$36 trillion. Trump angling to make the $1 trillion-plus tax cuts from his first 2017-2021 term permanent and add new ones will exacerbate the problem.
At present, the magnitude of the US net foreign investment position – the difference between foreign assets that Americans own and those assets owned abroad — is nearly the size of US GDP. It’s negative $24 trillion compared with negative $18 trillion when Trump left office in 2021.
On Trump 2.0’s watch, though, the US will face a fork in the financial road: push its excesses further into the red or devise a strategy to reduce Washington’s dependency on imports.
So far, Team Trump seems more willing to go the former route than the latter. More tax cuts would increase America’s reliance on the savings of Japan, China and Global South developing nations. His tariffs and trade barriers would boost US inflation and curb consumption.
That could mean slower US growth and less demand for Chinese goods at a moment when Beijing faces weak retail sales and deflation. Chinese households might have even less wherewithal to buy US goods. It also might increase the odds China weakens the yuan to keep exports competitive, kicking off a giant currency war.
“Beyond alienating friends and partners, Trump’s tariffs will probably fail to advance his apparent goal of reducing the US trade deficit,” says Takatoshi Ito, a Columbia University economist who served as Japan’s deputy vice minister of finance.
Ito adds that “if other countries adopt retaliatory tariffs, total exports from the US – and global trade overall – may well decline. Moreover, high US tariffs would fuel domestic inflation, forcing the Federal Reserve to raise interest rates, which would probably cause the US dollar to appreciate, causing exports to fall and imports to rise.”
Trump, Ito warns, is also set to increase America’s fiscal deficit, as he has promised sweeping tax cuts without identifying spending cuts that would make up for the lost revenue. As fiscal deficits undermine national savings and investment, the trade deficit, too, will grow. “In other words,” he notes, “like President Ronald Reagan in the 1980s, Trump is likely to preside over twin deficits.”
James Knightley, chief international economist at ING Bank, says the “increase in the cost of goods, coupled with potential supply-side constraints in the labor market as a result of Trump’s proposed immigration policies, could also lead to a one percentage point increase in inflation.”
Naturally, Trump will point the finger elsewhere, accusing Washington’s trading partners of “dumping” goods or maintaining artificially low exchange rates.
“Some observers, including myself, speculate that Trump’s pick for Treasury Secretary, Scott Bessent, might even call for a special G20 meeting to pressure other countries to revalue their currencies vis-a-vis the dollar, a move that would recall the 1985 Plaza Accord,” Ito explains.
Ito concludes that “unless Trump takes a prudent approach to tariffs on imports from the rest of the world, it is the US that will be contained, in terms of both economic dynamism and global influence.”
Thickening the plot, Trump has hinted at engineering a weaker dollar exchange rate and commandeering the Federal Reserve’s decision-making authority. Neither inclination bodes well for the global inflation outlook, America’s credit rating or investors’ trust in the buck.
As 2025 begins, all eyes are on Moody’s Investors Service, the only major credit rating company to still grade the US AAA. That might change fast if the next US Congress plays games with the debt ceiling or shuts down the government to score political points.
All this comes against the backdrop of waning overseas demand for US government debt. For over a decade now, foreign official institutions have been scaling back on US Treasury securities. The void has been filled by domestic financial institutions.
Trouble is, a sharp drop in US stocks could make American assets less attractive to overseas buyers, leaving domestic funds in the red. That would make it even more implausible that US financial institutions could finance a government deficit of 6% of GDP.
Economists agree on how America must reduce its addiction to imports. The key is increasing productivity, rekindling innovation and creating a new manufacturing model. That means increasing training to strengthen human capital, incentivizing a new generation of industrial entrepreneurs and improving infrastructure.
It also means investing more in semiconductors, artificial intelligence and other sectors to raise America’s innovative game. The ways in which Boeing, General Motors, Intel and other pioneering brands risk becoming also-rans should have Washington scrambling to revitalize corporate America.
Biden pivoted somewhat toward building more economic muscle at home. The Trump 1.0 era was about tripping China on the racecourse. Biden focused more on limbering up to compete with China the organic way.
Case in point: the CHIPS and Science Act that Biden signed into law in 2022. It deployed $300 billion to strengthen domestic research and development. Biden took other steps to incentivize innovation, raise America’s semiconductor capabilities and increase productivity.
It marked a change from the Trump era, the centerpiece of which was a $1.7 trillion tax cut that did little to raise competitiveness or increase domestic capacity. Had Trump’s tax scheme boosted innovation and productivity, US inflation might not be rising at a 2.7% year-on-year rate.
Economist Ken Heydon at the London School of Economics warns of the “risks of regulatory capture,” whereby regulations are influenced by targeted industries rather than the public interest.
Biden, he explains, retained most of Trump 1.0’s trade restrictions, which he calculates are reducing US GDP by $55.7 billion, decreasing wages and costing full-time equivalent jobs.
“As for ‘fixing’ the trade imbalance, over Trump’s first presidency the US trade deficit soared to its highest level since 2008, increasing from $481 billion to $679 billion,” Heydon says.
Washington’s fiscal expansion policies mean the US will continue to spend more than it produces, perpetuating the “underlying reason for the trade deficit,” in the first place, Heydon adds. He argues that a tax on imports is thus, in effect, a tax on exports.
The impact, Heydon notes, is both direct through raising the cost of inputs, stifling productivity-enhancing competition and prompting retaliation and worsening of trade conditions, as well as indirect through currency appreciation and permitting wage increases in the import-competing industries, which then spill over to the broader economy.
Unfortunately, neither Trump 1.0 nor Biden rolled out credible plans to rival Beijing’s multi-trillion-dollar effort to lead the future of electric vehicles, robotics, semiconductors, renewable energy, artificial intelligence, biotechnology, aviation, high-speed rail and other sectors.
Instead, Biden also resorted to tariffs, joining Trump back to the 1980s, when such policies might have worked. Trump has long been trapped in that era, one in which Japan inhabited the nemesis role China does today.
Between 2017 and 2021, Trump’s advisors tried to make 1980s-style trickle-down economics great again. They failed, just as Trump’s top Asia ally in Tokyo did. Then-Prime Minister Shinzo Abe also thought the recipe for greater prosperity was surging stocks. Wages didn’t rise much, though, undermining the broader economy.
The barrage of tariffs that Trump is now promising might come just as his incoming administration has what Chatham House economist David Lubin calls “a dollar problem.” Lubin notes that in recent months, Trump “has shown a clear preference for a weaker exchange rate to support the competitiveness of US exports and help reduce the US trade deficit.
And yet, “as the market has sensed since the US election,” Lubin says, “the much more likely outcome is that his policies end up strengthening the greenback. The risk is that the US dollar – which is expensive already – becomes more obviously overvalued, and this could increase the risk of global financial instability.”
The dollar, Lubin adds, probably has a fair amount of room to keep going up, since it is not obviously overvalued just yet.
“The US current account deficit – the broadest measure of a country’s trade deficit, and a rough but useful measure of financial vulnerability – was a little over 3% of GDP last year. This is around half the level it reached in 2006, just before the 2008 global financial crisis, meaning the risks arising from an overvalued dollar may be for the latter part of Trump’s second presidency.
“A rising dollar can often be bad news for the global economy. It “tends to depress global trade growth, restrict developing countries’ access to international capital markets, and make it more difficult for countries whose currencies will be weakening to keep inflation under control,” Lubin says.
“If and when the dollar becomes unsustainably expensive, a further problem will present itself: how to deal with an overvalued currency without risking a lot of financial dislocation,” he adds.
It’s unclear how Trump’s desire for a weaker dollar might play out and what it might mean for Asia’s 2025. But with the bill coming due for decades of American profligacy during the Trump 2.0 era, China may find itself in harm’s way as Washington sends massive headwinds its way.
Follow William Pesek on X at @WilliamPesek
