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You Can't Blame Trade For The Economy's Troubles

Business Outlook


The debate over the General Agreement on Tariffs & Trade has become the first battleground between Congress and the White House. So trade and international markets are central themes in the volley of rhetoric fired between Republicans and Democrats. Lost among the partisan salvos, however, may be the fact that foreign trade is already a significant part of this economy, and its importance will continue to grow.

In fact, foreign demand will be especially crucial to economic growth in 1995 when manufacturers will have to search for new markets as demand in the U.S. slows. Indeed, exports are poised to grow faster in 1995 than they did in 1993 or 1994. Factors such as infrastructure-building in emerging markets, a recovering Europe, and the cheap dollar all will converge to lift foreign purchases of American-made goods.

At the same time, the slowdown of domestic demand in the U.S. should dampen the influx of imports. However, imports are still expected to grow faster than the overall economy next year. So a greater share of goods bought in the U.S. will be made somewhere else.

Taken together, the pickup in exports and the slowdown in imports suggest that the foreign trade deficit may be bottoming out right now (chart). And 1995 will see some narrowing in the trade gap, even as it brings a more moderate economy. Indeed, it is the prospect of weaker growth next year, along with fears of higher interest rates, that have rattled the stock market. Stock prices tumbled in the days before the Thanksgiving holiday.

Foreign trade did continue to worsen in September. The deficit for all goods and services widened to $10.1 billion from $9.7 billion in August. Imports rose for the fifth straight month, increasing 0.3%, to $69.8 billion. Exports, however, fell 0.5%, to $59.7 billion in September. For goods alone, the deficit increased to $14.6 billion from August's $14.1 billion.

DESPITE A DROP in September, merchandise exports have been doing much better now than they were in 1993. Foreign shipments are up 14.9% from a year ago. Last September, they were growing a mere 3%.

The big gains have been in Mexico, where the North American Free Trade Agreement has opened up markets, and in areas where economic growth is booming. Exports to Mexico are up 21.7% so far in 1994 compared with 1993. Along the emerging nations of the Pacific Rim, exports are rising 12.6%, and in Latin America, they have grown 10%.

The dollar--the 90-pound weakling of the currency markets-- has helped to supply the muscle for U.S. manufacturers in the emerging markets. True, most of these nations peg their currencies to the U.S. greenback. But the cheaper dollar has given American manufacturers a price advantage over their major competitors from Japan and Germany. The dollar has fallen 13% against the yen and 12.2% against the mark since the start of the year.

The currency advantage has been vital in boosting overseas demand for capital goods made in the U.S. Shipments of capital machinery are growing faster than exports overall.

Against European rivals, U.S. companies will likely start to lose that pricing edge sometime in the first half of 1995. That's because the dollar may start to strengthen against European currencies. A big reason: Short-term interest rates here are above rates in Germany for the first time in four years.

The latest Federal Reserve move on Nov. 15 pushed the federal funds rate--the cost of interbank borrowing--above the comparable rate of the German Bundesbank (chart). Lower German rates should make dollar-denominated securities--and thus, the dollar--more attractive to foreign investors.

THE DOLLAR will probably continue to have problems against the yen, though, because of America's massive trade deficit with the Japanese, now about 40% of the U.S. trade shortfall with the entire world. In September, the trade gap improved only slightly, to $5.4 billion from $5.8 billion in August.

U.S. trade deficits with other nations are soaring as well. After Japan, our second-biggest deficit is with China. In September, the U.S. bought $3.5 billion more in goods from China than it exported. That's up from $3.2 billion in August. In the first nine months of 1993, U.S. trade with Europe was roughly in balance. So far in 1994, the trade gap with Europe has widened to nearly $9 billion.

The big reason for the trade deficit is the influx of imported goods. Merchandise imports are up 12.6% so far in 1994. Businesses are leading the import binge, though some of their purchases are used as part of the manufacturing process here at home. Imports of capital goods are up 20.4% this year, with big increases of computer parts, telecommunications equipment, and semiconductors. Imports of nonoil industrial supplies have increased 16%.

Import growth will taper off only when domestic demand feels the downward tug from tighter Fed policy. That pull will be stronger in 1995. So far, housing has been the primary victim of monetary policy, subtracting slightly from economic growth in the third quarter. In October, housing starts fell 5.2%, to an annual rate of 1.42 million. Single-family starts fell a steeper 7.4%, to a 1.14 million pace (chart).

STILL, HOME BUYING has held up fairly well in 1994, despite higher mortgage rates. That's because buyers have switched to adjustable-rate mortgages. But even these rates are becoming less enticing. According to HSH Associates, the initial rate for a one-year ARM stood at 6.33% in mid-November, almost where 30-year fixed rates were last October.

With affordability becoming more of an issue, demand is sliding. Mortgage applications in the first half of November were about even with their October average, which was down from September's pace. In addition, the National Association of Home Builders said that just over half of its members reported low buyer traffic in October, the sparest traffic reading in almost three years.

The rise in short-term interest rates won't just hit housing. For homeowners with ARMs, the Fed tightening means higher monthly house payments. So more money will have to be budgeted away from other spending. Likewise, the boost in banks' prime lending rate will lift the interest cost of small-business borrowings, home-equity loans, and credit-card balances.

Of course, less borrowing is part of the Fed's plan to slow this economy and hold inflation under wraps. The increased demand from abroad, however, will complicate the Fed's job. If manufacturers can sell their product overseas easily, they will not have to hold the line on prices. That's one reason why the Fed will probably have to hike interest rates further in 1995. But for exporters, the increased demand overseas will offer a safety valve for their businesses, even as customers in the U.S. scale down their buying plans.JAMES C. COOPER & KATHLEEN MADIGAN

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