An Unbalanced Treatment of the Balance of Payments

The courts have not been tolerant of the Trump administration’s legal arguments in support of global tariffs. In February the Administration lost at the Supreme Court, which rejected its “emergency” powers claim under the IEEPA statute. The administration reimposed the tariffs, pivoting to Section 122 of the 1974 Trade Act, which had never been invoked.

Section 122 authorizes a president to impose a temporary tariff of up to 15% for 150 days to address a “large and serious United States balance-of-payments deficit.” No such deficit exists, at least not by the definition Congress intended.

This May, the U.S. Court of International Trade (CIT) agreed. They held that the president needed to show the existence of a balance-of-payments (BOP) deficit, as understood when the 1974 statute went into effect. The administration’s appeal, now before the Court of Appeals for the Federal Circuit (CAFC), needs a way around the CIT ruling.

This July, the Council of Economic Advisers (CEA) supplied one by retrofitting a new definition into the 1974 terminology. The CEA released an unsigned report claiming the current account—an accounting measure of international trade in goods and services plus income flows—is how economists have always measured a BOP deficit. Sensing that this might be controversial, the report provides a backup measure, just in case. It reconstructs a version of a long-discontinued accounting measure called the basic balance, and claims that it is the “most expansive candidate BOP deficit measure.”

Both claims deserve more scrutiny than they’ve received.

A country’s overall BOP must sum to zero. That is by accounting definition. When domestic buyers send money out to bring imports in (the current account), foreign exporters return money domestically as investment (the capital & financial account). The BOP is a form of double-entry bookkeeping applied to international trade.

But it also means that the current account—composed mostly of trade in goods and services—can be in deficit, while the capital & financial account is in surplus. When Americans run a current-account deficit, foreigners are simultaneously acquiring more dollar-denominated assets: Treasury bonds, corporate equity, real estate, and direct investment in U.S. commerce. The United States remains, by a wide margin, the world’s top destination for foreign capital. Inflows run several times those of the next-largest country recipient of foreign investment.

This reality is difficult to square with the concerns raised in Section 122. So-called “sudden stop” or currency crisis scenarios, both emphasized in the CEA report, were the types of exigencies that gave “balance-of-payments deficit” its urgency under the Bretton Woods currency peg regime. Whatever is happening in the modern U.S. economy, it isn’t a drawdown of reserves in defense of a currency peg. The U.S. formally abandoned the Bretton Woods system in 1976.

The CEA’s argument is selectively assembled. It cites reputable studies, claiming that they endorse using the current-account deficit is a reasonable and reliable measure of a BOP deficit. But the cited studies don’t say that. In fact, they argue the opposite. The two studies, both published by the Federal Reserve in 1975, argue that fixating on any single balance, including the current account, is likely to mislead policymakers into unnecessary trade restrictions. One of the sources goes further, warning that expecting a construction of the basic balance to provide reliable insights of balance of payment conditions is “doomed to disappointment.” A reader who checks the footnotes finds the literature arguing against the report’s central premise, not for it.

As filing deadlines for the administration’s appeal arrive soon, the Courts and the public are being asked to treat the CEA report as neutral economic expertise rather than as advocacy manufactured for litigation. But it is a reverse-engineered definition to fit a legal conclusion already reached, and it falsely portrays its arguments as having support from reputable studies. The courts, and the rest of us, should notice the difference.