The US Trade Deficit and Foreign Borrowing

How Long Can It Continue?

The US has been running significant trade deficits for the last five decades, leading to a growing net international liability position (NIIP). While the deficit was fairly stable from 2013-2019 at 2% of GDP, it then more than doubled and put the deficit on an unsustainable path. Tamim Bayoumi and Joseph Gagnon, authors of the July 2025 paper "The US Trade Deficit and Foreign Borrowing: How Long Can It Continue?" investigated the underlying causes, risks, and implications of the US trade deficit, offering valuable insights for investors and policymakers alike.

Bayoumi and Ganon set out to analyze:

• The drivers behind persistent US trade deficits, the largest cause of the current account deficits: Why has the US been able to sustain large external deficits for so long?

• The role of foreign investment: How does the attractiveness of US financial assets support ongoing borrowing?

• Risks to sustainability: What could threaten the US’s ability to finance its deficits in the future?

• Policy impacts: How have recent policies, such as tariffs, influenced the trade deficit and foreign borrowing environment?

Key Findings

1. Attractiveness of US Financial Assets

• The US dollar’s central role in global transactions, its perceived safety, innovation of US financial markets, and the size of the US markets, have made US assets relatively attractive to central banks, sovereign wealth funds, and private investors. The attractiveness of US assets puts upward pressure on the dollar, driving the external deficits. (Note: Despite this year’s decline, the US dollar remains overvalued with purchasing power parity (PPP) models estimating that the dollar is still about 15% above its fair value.) However, the dollar’s attractiveness has allowed the US to finance its deficits at a relatively low cost. And lower interest rates support higher US asset prices.

2. Net International Liabilities Are Growing

· The US NIIP has become increasingly negative reflecting the accumulation of foreign claims on US assets—and the trend is clearly unsustainable in the long run.

3. Recent Policy Shifts Increase Risks

• On April 2, 2025, President Trump announced the largest tariff increase in US history, the purpose of which was to eliminate the chronic US trade deficit. This view is based on a mercantilist view that surplus countries are winners and deficit countries are losers from trade. The “tariff war” has heightened uncertainty and discouraged investment.

• While these actions may temporarily reduce the trade deficit by slowing US growth and weakening the dollar, this strategy puts at risk the longstanding ability of the US to finance external debt at low cost, increasing the burden on future generations.

4. Long-Term Sustainability in Question

• The current path is unsustainable: persistent deficits and rising liabilities will eventually require adjustment. Bayoumi and Ganon estimated that that a significant, but not unprecedented decrease in the trade deficit of 2% of GDP is needed to make it sustainable—moreover, if the United States were to lose its ability to borrow at a very low rate of interest, the required adjustment could almost double, making sustainability much more difficult to achieve.

• The US’s unique position may delay a reckoning but cannot prevent it indefinitely—with nominal GDP growth of say, 4%, the US cannot sustain a current account deficit of 6% of GDP as it would imply a steady-state NIIP of –150 percent of GDP.

Their findings led Bayoumi and Ganon to conclude: “The combination of US policies that maintain or increase excessively large fiscal deficits while destroying US trade relationships is reducing US wealth and rapidly removing the US ability to finance deficits cheaply. The costs to businesses and consumers are likely to be high.”

Key Takeaways for Investors

· US assets remain attractive due to their safety and liquidity, but this advantage is not guaranteed forever. Foreign governments could further reduce their holdings of US dollars as reserves (in retaliation for tariff increases, fear of confiscation as is the case with Russia, and also for geopolitical reasons), putting upward pressure on US interest rates—which would not only be drag on economic activity, but would put further pressure on the budget deficit, and negatively impact US asset prices in general. According to an OECD report, sovereign debt in developed countries will reach nearly $59 trillion this year. Central banks will own about $11 trillion of that, down from $15 trillion four years ago. That means other investors have to fill the gap and also soak up massive issuance—interest rate risk is rising.

• Policy uncertainty can undermine investor confidence and alter capital flows, impacting asset prices and exchange rates.

• Long-term risks are rising. Diversification may help mitigate potential shocks if the US’s ability to finance its deficits is challenged.

Summary

Bayoumi and Ganon argued that the persistent US trade deficit and reliance on foreign borrowing have persisted reflects: “Unique features of the United States, including the large size and relatively strong growth of its economy and the dynamism and creativity of its financial and technology companies. More specifically, the US seems to be better at creating marketable securities, including safe assets, that foreign investors wish to buy. These features make US assets attractive to foreign investors and enable the United States to run large current account deficits at comparatively low rates of interest. US trade deficits were also supported by mercantilist currency policies in some of its trading partners, especially during the period from 2003 through 2013.” However, this situation is not without risk. Recent policy moves have introduced new uncertainties, and the ever-growing net international liabilities point to an eventual need for adjustment, most notably in the US fiscal deficit. It also raises the risk that investors will no longer see US assets as safe, implying an end (possibly abrupt) to the favorable funding rates implied by the “exorbitant privilege” we have enjoyed due to the dollar’s role as a reserve currency.

Larry Swedroe is the author or co-author of 18 books on investing, including his latest Enrich Your Future. He is also a consultant to RIAs as an educator on investment strategies.