Foreign trade is expected to be the expansion's cavalry this year, galloping forward just in time to rescue the economy from a fate worse than slower growth. You only have to look toward the heated U.S.-Japan trade talks to grasp how important trade has become. In fact, exports contributed more than a quarter of the growth of real gross domestic product over the past year.
The worry is that trade will end up more like the economy's Little Bighorn. After all, depending on foreign economies that are influenced by different cyclical factors and monetary policies can be risky. Already, growth projections worldwide have been downgraded because of the problems in Japan and Mexico, and Europe's recovery may soon lose its bloom.
Exports should be able to hold off those attacks, however. The weaker dollar, increased productivity, and falling unit labor costs give U.S. manufacturers a big advantage over their competition. And emerging nations in Latin America and along the Pacific Rim will continue to increase their demand for capital and consumer goods, many of which will be U.S.-made.
Of course, bringing down the U.S. trade deficit will also require slower import growth. Luckily, imports should ease in response to weaker U.S. demand. Already, the durable-goods sector is losing steam (chart). And the narrowing of the federal budget deficit continues to be a drag on domestic growth. Little wonder, then, that the Federal Reserve did the expected at its May 23 meeting: It left interest rates unchanged.
EVEN IF the outlook for the rest of 1995 looks good, the trade picture hardly improved in March. Exports of goods and services did rise for the second consecutive month, increasing 5%, to a record $65.3 billion. But imports hit their own new high, rising 4.3%, to $74.5 billion. As a result, the trade deficit stood at $9.1 billion, about the same as February's $9.2 billion.
The March numbers indicate that the GDP net-export figure won't change much when the Commerce Dept. releases its first revision to GDP on May 31. The wider trade deficit subtracted almost a percentage point from economic growth last quarter.
As a result, trade did not offset what will likely be an upward revision to first-quarter inventory growth, which was already the fastest pace in 101/2 years. Faster stockpiling suggests that real GDP grew at an annual rate of more than 3% last quarter, up from the 2.8% pace first reported.
A BETTER-LOOKING first quarter is likely to come at the expense of the second, though. That's because retailers especially will have to wrestle their excessive inventories into better alignment with sales. That means fewer purchases of new merchandise. Already, orders for durable goods have been reduced to a trickle at U.S. factories, and fewer imports will be coming in.
New orders plunged 4% in April, the largest monthly decline in 31/2 years. Although the drop was broad, the transportation sector accounted for about half of the fall, explaining the auto industry's steep second-quarter production cutbacks. Orders for nondefense capital goods also dove, indicating that business outlays for equipment, while still healthy, will not maintain their robust 1994 pace.
To avoid massive production cuts and layoffs, U.S. businesses will have to depend on foreign customers to keep assembly lines humming. That's why the latest economic forecast done by the Organization for Economic Cooperation & Development raises some doubts about the trade picture. The OECD forecasts that the 25 major economies will grow by an average of 2.7% this year. That's down from the 3% growth rate projected by the OECD back in December.
The two biggest factors in the downward revision were the questionable recovery in Japan and the financial crisis in Mexico. Those two countries are America's two biggest trading partners after Canada. But the U.S. trade deficit with Japan is the chief problem: In the past year, the monthly trade gap with Japan has averaged $5.5 billion, compared with the $7.9 billion deficit with all other countries combined (chart).
Even so, U.S. exporters will still carry the day, because 44% of their goods go to countries outside of Canada, Europe, and Japan. Most of these nations will grow faster than their more developed cousins. And because the dollar has fallen against the yen and mark, U.S. businesses in these markets have a price advantage over their Japanese and German competitors.
True, many emerging nations link their currencies to the dollar, so U.S. companies cannot directly cut prices when they export to these countries. However, they have a price edge over the Japanese and Germans, who must choose between raising prices or losing profits because of their stronger currencies. Increased sales to emerging markets is a key reason why export growth will continue to strengthen.
How important will exports be in the second half? If exports fail to sizzle, GDP growth could fall closer to 1% than 3%. That means higher unemployment and rising odds that the Federal Reserve's next move will be to cut short-term interest rates.
Foreign workers will also be hurt. First-quarter imports captured a record 27.4% of U.S. demand for nonoil goods (chart). That means overseas manufacturers will take a hit from the U.S. slowdown and inventory realignment. But weaker imports will improve the trade gap by a fair amount by yearend.
A CONTRIBUTOR to the trade troubles has been America's towering public deficit. The red ink of federal, state, and local governments, coupled with weak savings, has hiked the need for foreign funds to finance U.S. investment. That's why GOP efforts to balance Washington's finances may someday turn the tide on the trade deficit.
If the public posturing and behind-the-scenes lobbying are any indications, though, that process won't happen overnight. What will help this year, at least, is the prospect that the deficit in fiscal 1995 is on track to shrink to its smallest total in six years.
The Treasury Dept. reported a surplus of $49.7 billion in April, the largest monthly surplus on record, as personal tax receipts rose 27.3% from a year ago. The calendar played a part in the windfall: Because Apr. 1 fell on a Saturday, entitlement checks were mailed in late March, adding to that month's red ink.
For the first seven months of fiscal 1995, which ends Sept. 30, the deficit totals $94.3 billion, half of its total in the same period of 1992. That suggests that the budget gap could end the year at less than $165 billion--the thinnest trail of red ink since 1989.
Of course, a shrinking deficit takes stimulus out of the economy. Witness the defense cuts. Add in weaker consumer spending and some slowing in business investment, and these sectors tally up to weaker growth. That's why in the coming months, foreign--not domestic--demand will need to play a big role in keeping the economy on the beam for a soft landing.