Does the U.S. really want to eliminate the trade deficit? Deutsche Bank: It's simple, a 40% depreciation of the dollar is enough

Deutsche Bank economist Peter Hooper proposed a seemingly "simple" solution to eliminate the U.S. trade deficit in his latest research report—devaluing the dollar by 40%.

The report points out that fluctuations in the real exchange rate of the dollar are the most persistent driving factor behind the U.S. trade deficit, and reversing the 40% real appreciation of the dollar over the past 15 years may be sufficient to bring the trade deficit back to zero balance.

However, a significant devaluation of the dollar would have a severe impact on global markets, with emerging markets and export-oriented economies facing serious blows, potentially leading to a global economic recession.

Hooper believes that while existing tariff policies may help narrow the deficit, they come at the painful cost of rising prices and slowed growth. Therefore, the U.S. government may shift its policy in the future, abandoning a tariff-focused trade policy.

Core Driving Factors of the U.S. Trade Deficit

The Deutsche Bank report identifies the key factors driving the U.S. trade deficit to its current level. The report states that fluctuations in the real exchange rate of the dollar are the most persistent driving factor behind the U.S. trade deficit, primarily driven by fundamental shifts in fiscal and monetary policy as well as changes in private and government savings abroad.

The report specifically mentions that the U.S. deficit with the rest of the world has expanded to unprecedented heights. After Trump took office, he implemented the largest tariff policy since the Great Depression, officially to address this issue.

The "Solution" of a 40% Devaluation of the Dollar

Deutsche Bank's key finding is that the real exchange rate of the dollar has appreciated by about 40% against a basket of currencies over the past 15 years, and reversing this appreciation may be sufficient to bring the U.S. trade deficit back to zero balance or better levels.

Charts in the report show that a 20-30% devaluation of the dollar may ultimately be enough to reduce the deficit by about 3% of GDP. This means that if the dollar can significantly reverse its approximately 40% real appreciation since 2010, it could bring the current deficit back to a zero balance.

Potential Impact on the Global Economy

The report warns that a 40% devaluation of the dollar would have catastrophic effects on the global economy. Since most emerging market economies and much of Europe are export-driven, a 40% drop in the dollar would translate into a 40% appreciation of other currencies, potentially leading to a global economic recession.

Deutsche Bank believes that while there are more effective and less painful alternative paths to address the trade deficit, this preferred path may currently be politically unfeasible. However, the report anticipates that as the negative economic impacts of the current tariff-focused policies become more apparent in the coming months, public pressure will drive a policy shift.

Tariff Policy May Be Reversed

However, Deutsche Bank believes that the current tariffs can indeed narrow the trade deficit to some extent. This is due to two reasons:

1. Foreign retaliation against the U.S. aggressive tariff policy may be more hesitant and moderate than in the past.

2. Trump's tariffs have led to a depreciation of the dollar, rather than the usual appreciation that accompanies tariffs.

However, the report emphasizes that the tariff policy has come at a significant cost in terms of increasing prices and reducing output, and these negative effects are expected to become apparent in the coming months and may last for years.

The report points out that while there is no painless way to reduce the deficit, a depreciation of the dollar may be a****more effective and less painful path. This preferred path may currently be politically unfeasible. However, as the negative economic impacts of the current tariff-focused policy become increasingly evident in the coming months, public pressure to reverse this policy is growing