The math behind Trump’s three-arrow plan to cut US deficit—what the third move could mean for the world economy
Summary
- To shrink the US current account deficit, Trump has already fired two arrows—at trade and the federal budget. But the math suggests a third, more dangerous move could be next.
President Donald Trump’s flip-flops on tariffs—starting with the Liberation Day announcement, followed by a 90-day pause, and then exemptions on select items—have kept the world guessing. But it would be a mistake to dismiss these actions as random or uninformed. In fact, Trump’s trade and fiscal manoeuvers so far appear to revolve around a single macroeconomic equation.
The equation is simple: a country’s current account balance equals the gap between its savings and investment. In other words, to eliminate a current account deficit (CAD), a nation must either boost savings, cut investment, or both. Trump has made it clear he wants to shrink the US CAD. Here’s how that could play out.
The US runs a persistent current account deficit—meaning it invests more than it saves. The savings-investment gap can come from both the government and the private sector. In the case of the US, while the federal government runs a deficit, the private sector has net surplus savings. In 2024, the overall US current account deficit stood at $1.1 trillion, the sum of a $1.8 trillion government deficit and a $699 billion private sector surplus.
Now, essentially, to cut CAD, Trump has “three arrows" in his quiver, to borrow an analogy from the late Japanese prime minister Shinzo Abe. Each targets a different piece of the macroeconomic puzzle: the trade deficit, the budget deficit, and capital inflows. The trade deficit in particular looms large—it accounts for 86% of the CAD.
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The first arrow is a direct hit on the trade deficit, and has already been fired in the form of tariffs. The primary impact of tariffs is to make imports more expensive for American consumers. The secondary impact, also visible, is that trading partners are scrambling to re-work trade deals in ways that boost US exports.
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The second arrow aims to reduce the federal deficit: a smaller deficit means that less private inflows are needed to balance the current account. The Department of Government Expenditure (DOGE), helmed by Elon Musk, claims to have saved $150 billion in federal spending so far. In addition, new tariffs are expected to generate revenue. Recent reports estimate that $500 million has been raised since 5 April. Collectively, it doesn’t amount to much, given the size of the budget deficit, and the fact that many spending items are inflexible (such as interest payments and social security).
The third arrow, the most dangerous, is yet to be unleashed: a potential strike on capital inflows.
Stephen Miran, the Trump’s economic advisor, has written about the costs of issuing the world’s reserve currency. His view is that the dollar is overvalued because of the influx of foreign money into the US markets. Team Trump wants the dollar to remain dominant—but they also wouldn’t want to keep it excessively strong as that would make exports less competitive. What could then happen next? A possible Mar-a-Lago accord in which countries would sell dollars, while swapping short-term US treasury holdings for long-term ones?
The hoped-for result for the US is that the dollar would weaken, but countries would continue to hold long-duration dollar assets in their reserves.
Read this | Mint Primer: How will Trump’s next obsession, a weaker dollar, play out?
There is even talk of a tax on short-term capital inflows, to discourage inflows of hot money. Some of this itinerant global capital could find its way to emerging markets, including India, or it could boost inflows into crypto assets or gold. Or, if European growth picks up, the Euro or Swiss franc could take up some funds that seek safe avenues.
Where we stand
It’s too early to say whether the first two arrows have hit their mark, and the third is still speculative. In fact, two recent developments suggest the opposite. First, the House of Representatives passed a budget bill extending Trump’s 2017 tax cuts, and the president is now advocating for more cuts. With uncertain gains from tariffs and modest spending reductions delivered by the DOGE, the budget deficit may actually widen.
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Secondly, as countries respond to tariffs in ways that serve their own national interests, the targets of Trump’s arrows will keep shifting. For instance, a devaluation of the Chinese yuan could drag down other Asian currencies, making the dollar relatively stronger and US exports less competitive. A sell-off of US treasuries by a few large holders could push up yields, raise borrowing costs, and complicate efforts to reduce government spending.
For now, it is impossible to predict how Trump’s strategies will play out. The only thing that’s clear is this: uncertainty is the new normal.
The author is an independent writer in economics and finance.
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