The U.S. president, Donald Trump, has launched a trade war against Canada, Mexico, and China by imposing tariffs on imports from these countries. One of the key reasons he has cited to justify these actions is the U.S. trade deficit with them. He interprets trade deficits as losses for the U.S. economy and claims that his tariffs will transform these losses into gains.

However, his interpretation of the trade deficit—or more broadly, the current-account deficit—as a loss to the U.S. economy is incorrect. According to a fundamental national income accounting equation, the current-account balance is the sum of private-sector savings in excess of investment (let’s call this private excess saving) and government-sector saving. For example, if private excess saving is zero, the current-account deficit will be equal to the government deficit. In other words, the current-account deficit reflects a country's total borrowing from the rest of the world. If the government runs a large budget deficit while the private sector does not save enough relative to the country's investment needs, the country will have a large current-account deficit. This is precisely why the U.S. has such a large current-account deficit.

In the table on the left, I present data on private excess saving, government-sector saving, and the current-account balance (all as a percentage of GDP) for the G7 countries and China. Government saving and current-account data are sourced from The Economist magazine, while private excess saving is computed using the national income equation.

The table shows that the four countries (China, Japan, Germany, and Italy) with current-account surpluses have private excess saving greater than their government budget deficits. For example, in China, private excess saving and the government's budget deficit are 7.1% and 5% of GDP, respectively. As a result, China can lend 2.1% of its GDP to the rest of the world, which appears as a current-account surplus.

The reason the U.S. has such a large trade deficit is that its private excess saving of 3.1% of GDP is insufficient to cover its budget deficit of 6.5% of GDP. Consequently, the U.S. needs to borrow 3.4% of its GDP from the rest of the world, which appears as the current-account deficit.

If President Trump genuinely wants to reduce the current-account deficit, he can do so by reducing the government's budget deficit and encouraging higher private-sector savings—not by imposing tariffs. 

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