The debate surrounding whether economics is truly a science is ongoing, with ideological preferences leading discussions on the policy measures intended to guide our economies on what is deemed the ‘right’ path.
However, one aspect remains indisputable: the unchanging accounting principles that form the basis of the balance of payments (BoP) for each nation and the world at large.
Former President Donald Trump frequently criticized the U.S. trade deficit, an essential component of the balance of payments accounting.
His lack of understanding of the fundamental principles underlying this complex economic equation led to both the imposition of controversial tariffs globally and a temporary retreat from some of these measures.
So, what exactly is the BoP?
In its most basic terms, the BoP encapsulates all transactions between countries, aggregated on a country-by-country basis.
Simplifying further, the BoP comprises various components, including the current account that often finds itself at the heart of public conversations regarding trade balances.
Expressed as an equation, the overall balance of every country must adhere to this format: Current Account Position + Capital Account Position + Changes in Reserves = 0.
Countries with a combined surplus in their current and capital accounts will see an increase in their reserves, typically denoted as a negative value.
Conversely, nations experiencing a combined deficit in their current and capital accounts will need to tap into their reserves, represented as a positive value.
Therefore, the overall balance on the BoP will invariably result in zero.
Notably, exceptions exist.
For instance, countries that maintain persistent combined deficits in their current and capital accounts and have exhausted their reserves are essentially insolvent and must seek borrowing options via platforms such as the International Monetary Fund.
Another significant exception is the United States.
As the sole global reserve currency, the U.S. dollar creates a unique scenario where, by definition, the United States holds virtually no foreign reserves.
Why is this important?
The United States, partly due to its advanced economic stage, operates with a chronic current account deficit, which includes the often-maligned trade deficit.
This current account deficit is entirely balanced out by an equivalent surplus in the capital account.
With some of the deepest capital markets worldwide, the dollar serves as the reserve currency, prompting other nations to invest heavily in U.S. stocks, fixed income instruments, corporate bonds, and particularly U.S. treasury bonds, bills, and notes.
Such dynamics, along with significant foreign direct investment into the United States, contribute to a substantial capital surplus that maintains the balance of payments in equilibrium.
To put it differently, the United States does not accumulate reserves nor does it need to draw upon them.
As previously pointed out, there is, therefore, little need for reserves.
However, the landscape shifted with the escalation of the tariff battle, particularly with China’s aggressive retaliatory measures and actions from Canada and the EU.
Astute observers recognize America’s Achilles heel: the capital account.
In response, French President Macron, in his characteristic charm, urged French enterprises and investors to curtail their investments in the United States.
China, more reliant on trade than France, has vowed to ‘fight until the end,’ engaging in a tariff war that could potentially cripple trade with the United States.
Both nations are well-aware of the stakes, and this war serves both domestic political purposes and China’s broader goal to counter U.S. strength.
Critically, their strategy aims at impacting the U.S. where it is most vulnerable—its capital account.
Currently, 24% of the U.S. Treasury debt, which exceeds $36 trillion, is held overseas.
While China officially holds $760 billion, its indirect ownership could elevate its total holdings to about $1.5 trillion.
Thus, restricting capital inflows into the United States poses a significant threat to U.S. consumers and the public sector, severely limiting their ability to spend beyond their savings.
This unfortunate reality resulted in skyrocketing yields on U.S. treasuries just days before Trump’s decision to pause tariffs.
Market interest rates for treasuries surged dramatically, with the possibility of a collapse in the U.S. treasury market looming large.
Even a reserve currency such as the U.S. dollar can face dire consequences.
Whether or not China liquidated its U.S. treasuries, fears of such an action caused market anticipations to rise, leading rates to increase.
A dwindling capital inflow puts the United States in a precarious position, mandating that the nation’s current account deficit must likewise contract.
Herein lies the risk associated with reserve currency status that could lead to sudden economic turmoil.
The United States lacks reserves as other countries maintain.
Instead, it must import capital excess.
Failure to achieve this could result in economic contraction or compel the government to print successive trillions of dollars, leading to hyperinflation rather than mere inflation.
The global implications of this current chaos, largely due to one man’s uninformed approach, cannot be overlooked.
Cutting off the United States from capital inflows, as nations might choose to do through reduced purchases of U.S. treasuries, represents the ultimate economic weapon wielded by major global powers.
The United States, however, cannot retaliate effectively within this realm.
Employing this economic weapon could lead to mutually assured destruction of the global economy.
Recent numbers from U.S. bond markets serve as a stark reminder of this reality, prompting Trump to utter a phrase likely to become iconic: ‘People went yippy.’
This term, ‘yippy,’ is a rarity in the English lexicon and appears to originate from the word ‘yips,’ referring to a golfer’s sudden incapacity to hit the ball due to nerves.
The U.S. bond markets displayed reasonable trepidation, mirroring Trump’s apparent inability to handle the economic terrain.
While Trump has paused several of the most extreme tariffs, including those on China, the overarching new tariffs remain entrenched.
This situation paints a bleak outlook for both the U.S. and the global economies.
The U.S.’s reliability as a participant in international trade and finance has been compromised, along with rising fears both stateside and abroad regarding the arbitrariness of contractual obligations, which include those involving the free flow of capital.
This reality has significantly diminished faith in the rule of law governing U.S. capital markets.
In light of this, the world may need to realign amid potential economic and political chaos, fraught with unpredictable outcomes.
Nonetheless, one certainty endures: International accounting principles related to the world’s balance of payments will persist, revealing the stark truths of economic realities, regardless of individual preferences.
image source from：https://www.theglobalist.com/united-states-donald-trump-economy-financial-markets-tariffs/
