There is one easy way for the U.S. to resolve a growing trade deficit—and perhaps a brewing tariff conflict—with China that is at the heart of a clash between the world’s biggest superpowers over import duties.
Goldman Sachs analysts led by Chief Econonomist Jan Hatzius said a recession, or weakened domestic growth, may be one quick method by which to slash the U.S.’s trade deficit, accounting for retaliatory measures by the world’s second-largest economy.
“For a deficit country such as the U.S., it is possible to scale up the trade restrictions sufficiently to achieve even an ambitious deficit reduction target. But this comes at a heavy cost in terms of weaker growth. Put simply, the only surefire way to reduce the deficit sharply under retaliation is a recession,” wrote Hatzius and his team in a Friday research note.
A recession is sometimes loosely defined as two consecutive quarters of economic contraction. In the U.S., the National Bureau of Economic Research serves as the official arbiter of the business cycle and defines a recession as a “significant decline in economic activity spread across the economy” that lasts more than a few months and shows up in a wide range of economic data, including gross domestic product and employment.
Trump has demanded a $100 billion reduction in the U.S.-China trade deficit, with that demand evolving recently into a series of threats and counterthreats on tariffs between Beijing and Washington over trade policies.
See: Why China’s Xi ‘cannot back down’ in trade battle with U.S.
Most recently, data for February showed that the U.S. trade gap—the difference between what the U.S. sells and what it imports with its international trade partners—was $57.6 billion (partially offset by a $19.4 billion surplus in financial and educational surpluses), hitting a nearly 10-year high and highlighting the challenge Trump is facing in cutting its deficit.
The data showed that U.S. trade deficits in goods with China ($34.7 billion), Mexico ($12.2 billion) and Germany ($12.9 billion) are running ahead of 2017’s pace.
The U.S. has been importing more goods largely because the economy is healthy and that can encourage households to buy foreign goods such as consumer electronics and vehicles, while underpinning further purchases by businesses. Moreover, a weakening dollar, which is down 2.4% so far this year, as measured by the ICE U.S. Dollar Index DXY, -0.36% also makes imports more expensive.
Goldman’s Hatzius says that the U.S. only exports about $150 billion of goods, compared with some $500 billion of imported China goods and services.
So, one of the clearest ways—and likely not a particularly palatable one—is a recession, Goldman writes.
“For example, a 1% of GDP fiscal contraction improves the U.S. trade balance sharply after two years if demand does not weaken abroad and around half that if trading partners also pursue contractionary policies. But this improvement in the U.S. trade balance comes at a high price as real GDP falls by more than 1% as a result of the fiscal contraction,” according to Goldman’s economists.
The Goldman report comes as the dispute between China and the U.S. has rattled the broader market, with the Dow Jones Industrial Average DJIA, +0.19% shedding 572 points on Friday and the S&P 500 SPX, +0.33% and Nasdaq Composite indexesCOMP, +0.51% declined by more than 2%.
That plunge followed a late-Thursday report that Trump requested the U.S. Trade Representative consider an extra $100 billion in Chinese goods to face tariffs and to identify the products that could be targeted.
China’s commerce ministry has responded to the latest tariff threat by saying it will respond with countermeasures if needed.
It is worth noting that there are few recessionary signals flashing red, according to recent economic reports, with the U.S. on track to extend its nearly decadelong run. According to BMO Capital Markets economists, a recession isn’t likely to occur tin 2018 and will probably be prompted by climbing inflation and a rise in interest rates.