There were two big surprises on Apr. 18. One was the Federal Reserve's rate cut at about 11 a.m. The other, just 2 1/2 hours earlier, was the Commerce Dept.'s announcement of a dramatic narrowing in the February trade deficit, which got lost amid the hoopla over the Fed.
It shouldn't have. The February trade gap for goods and services was a stunner. It shrank from $33.3 billion in January to $27 billion, far below expectations. The turnaround means that the steady widening in the trade gap in recent years is slowing, if only until the economy picks up again. As a result, the burden of financing the ever-increasing U.S. external debt will at least stop growing, although the IOUs are still enormous.
Make no mistake: The reason for the sudden shrinkage was a 4.4% decline in imports--the largest monthly drop on record (chart). While that plunge evinces weak U.S. demand, it also points up a key feature of this business cycle: the stabilizing influence of imports, which account for an increasing share of U.S. demand.
The steadying hand from trade can be seen in many ways. For example, with U.S. spending slumping and imports falling, the trade-deficit component of real gross domestic product narrowed in the first quarter for the first time in four years. That actually provided a plus for economic growth. Second, foreign companies are bearing some of the burden of dealing with excess inventories, since many of the goods in U.S. warehouses are imports. Finally, with the dollar still strong, inflation pressures from abroad remain minimal.
All this is just the opposite of what happened a year or two ago. Back then, when demand was booming at an unsustainable rate, imports satisfied part of the excess. Aided by a strong dollar, foreign competition helped to keep pressure off goods inflation, and the widening trade gap was a restraint on economic growth.
DESPITE SOFTER GLOBAL CONDITIONS, exports actually rose for the second month in a row, to $90.5 billion. The gain was led by a big increase in aircraft shipments. Excluding planes, exports declined, and they are unlikely to help reduce the trade gap in coming months. Softer foreign economic growth, already evident in Japan and elsewhere in Asia and now starting to be seen in Europe, will limit export gains.
Also, the 10% surge since early 2000 in the trade-weighted dollar, adjusted for prices across a broad array of countries, will hurt many U.S. exports by making them more expensive. The dollar is now at levels not seen since the superdollar days of the mid-1980s, although demand is always the more important factor.
That's why the broad nosedive in February imports, to $117.4 billion, was worthy of attention. It means that many foreign producers are helping U.S. companies shoulder the load of slower growth in consumer spending and business outlays for equipment. Put another way, the rest of the world is already feeling the impact of the U.S. slowdown. Although the U.S. is some 28% of world GDP, its global impact is far greater in terms of tradable goods.
Imports will weaken further in coming months, especially since businesses are cutting back sharply. Durable goods orders in March rose 3%, but that reflected big gains in defense and aircraft. Orders for nondefense, nonaircraft capital goods dipped 0.7%, the fifth drop in six months--a sign of still-slipping business confidence (chart).
Moreover, consumer jitters worsened in April. After rising in March, the Conference Board's index of consumer confidence fell back in April, erasing all of the previous month's gain. Households seemed increasingly nervous about employment conditions. The recent jump in gasoline prices means May confidence may not look any better. Still, consumers' actions belie their worries. Sales of existing homes in March rose to a near record level, and new-home demand hit an all-time high.
CONSIDERING ONLY GOODS, and excluding oil, foreign-made merchandise now accounts for 28 cents of every dollar spent on such goods, up from only 19 cents a decade ago. That surge partly reflects imports of high-tech equipment and components associated with the investment boom. Adjusted for falling prices of tech equipment, that share would be even higher.
In fact, the most dramatic shift in the U.S. trade accounts in recent years has occurred in capital goods. In only four years, the trade balance for capital goods, adjusted for price changes, has swung from a surplus of $27 billion to a deficit of $80 billion, accounting for a big chunk of the widening in the overall trade gap. While U.S. companies have been busy exporting the New Economy overseas, they have been importing high-tech gear and components at an even faster clip. On the plus side, the increase in imported tech equipment is helping to boost productivity and keep inflation low.
Moreover, you can bet that some portion of top-heavy tech inventories came from abroad, so the required inventory adjustment will affect output at overseas companies, at least partly diminishing the impact on U.S. production. For example, as U.S. businesses continued to cut back on outlays for capital equipment in the first quarter, imports of capital goods dropped 4.8% in January and a further 4.5% in February. In particular, semiconductor imports, which fell 7.6% in January, dove 9.5% in February.
BUT WHILE IMPORTS offer the economy some short-term stability, they are fast becoming a long-term problem. That's because the ever-swelling market share of imports is embedded in the structure of the U.S. economy. And that dependency means a continued rise in the U.S.'s foreign financial obligations, which have already reached levels that appear unsustainable.
By the end of 2000, the U.S. current account deficit, the broadest accounting of those obligations, was more than four times larger than it was at the end of 1995, and it had grown to a record 4.6% of GDP. Economists at Credit Suisse First Boston estimate that the U.S. is already commanding more than 80% of the world's excess savings in the effort to finance that gap.
For now, at least, foreigners show no signs of bailing out of U.S. investments. Despite the bust in tech stocks and the U.S. slowdown, the dollar continues to soar (chart). The greenback's strength reflects the belief of overseas investors that, despite the erosion of U.S. profitability in the short term, the long-run profit potential of U.S. investments remains compelling, compared with those in other parts of the world.
Global confidence in the Federal Reserve, and belief that the Fed's aggressive rate-cutting will revive sagging U.S. demand, are probably the most important supports under continued strong foreign investment in the U.S. The only problem: When U.S. demand does pick up, so will imports. And that will require even more foreign financing.
By James C. Cooper & Kathleen Madigan