The Hunger For Imports May Starve Future Growthby
The U.S. economy has a trade problem. No, it's not the result of weaker exports in a sluggish world economy. And no, it's not because of imports from Japan. The problem is America's ever-growing preference for foreign-made products, generally. This craving has reached proportions that clearly impeded the recovery's progress in the first quarter, and it may well be a key factor holding back U.S. manufacturing.
The most striking feature of the Commerce Dept.'s downward revision of first-quarter gross domestic product, from growth of 1.8% at an annual rate to only 0.9%, was the dramatic widening in the trade deficit. The gap is now calculated to have grown to $71.1 billion from $49 billion in the fourth quarter. That widening alone lopped nearly 2 percentage points off economic growth last quarter, and imports accounted for all of the deterioration.
Of course, imports normally rise as demand strengthens in a recovery. But what's alarming is that America is spending an increasing proportion of its income on foreign-made goods. Last quarter, imports of nonoil goods grabbed a record 24.3% of U.S. demand (chart). That share has jumped sharply, by 4 percentage points, since the recovery began two years ago.
American businesses account for most of the speedup. They are buying an increasing share of their industrial supplies and capital goods from abroad. Imports of such items now account for nearly 12% of U.S. spending on nonoil goods, up from 8.5% in 1988. By contrast, imports of consumer goods, including autos, snag a 9.6% share, up only slightly from 8.9%.
During the past year, imports of construction materials are up sharply, as are foreign-made computers and accessories, semiconductors, and industrial engines. This trend is, in part, a by-product of the rapid growth in foreign investment in the U.S. in recent years. And in general, the rising import share will remain a problem.
The interesting footnote to all this is that Japanese imports have played a small role. To be sure, the U.S. trade deficit with Japan is a big chunk of the overall U.S. trade gap, and access to Japanese markets remains difficult. But while goods from Japan account for 20% of U.S. nonoil imports, during the past two years they have contributed only about 12% of the growth in U.S. imports.
Greater-than-proportionate contributions have come from Canada, Mexico, and China. Taken together, those three countries account for 30% of total U.S. imports, but since the first quarter of 1991, they have contributed slightly more than half of U.S. import growth.
Japan seems destined to contribute even less to U.S. import growth because a weaker dollar will lift the price of Japanese imports in the U.S. Since January, the dollar has lost some 16% of its value against the Japanese yen. The dollar fell through 107 yen on May 28, and now currency traders are setting their sights even lower, to 105 yen or less, for the dollar's next support level.
Traders seem convinced that the Clinton Administration wants a weak dollar as a means to shrink its trade gap with Japan and as bargaining leverage to force greater access to Japanese markets. Recent mixed signals on dollar policy from U.S. Trea-sury officials only reinforce traders' beliefs.
Strong intervention attempts to stabilize the dollar-yen exchange rate by the Federal Reserve and the Bank of Japan on May 27 and 28 failed to halt the dollar's slide. The currency markets are not likely to take such efforts seriously unless they see that the U.S. is sufficiently concerned about dollar weakness to tighten monetary policy. For now, though, a U.S rate hike looks unlikely.
No doubt, heavy import competition is weighing on U.S. manufacturers, and that is one more problem that factories have to deal with in this historically weak recovery. Once again, the industrial sector is losing steam. In April, factory orders were stagnant, shipments fell, and the order backlog started to shrink again.
The weakness in new demand contributed to the slack showing in the government's index of leading indicators. The index--which is designed to foretell the economy's movements--rose just 0.1% in April. That small gain hardly recouped the 1% drop in the index in March.
Conditions in the factory sector did not improve much in May, according to the National Association of Purchasing Management (chart). The NAPM's index of industrial activity rose to 51.1%, but that's not much better than April's 49.7%. The May reading was barely above the 50% mark, the dividing line between expansion and contraction in manufacturing. Although orders and output rebounded, the bounce was not very high, and employment continued to contract, says the NAPM.
In coming months, however, manufacturers are likely to get a lift from stronger demand. In particular, consumer spending this quarter is on track to improve its skimpy 1.2% annual pace in the first quarter.
Also, some retracement of last quarter's widening of the trade deficit is likely. First-quarter import growth was far above its recent trend, and the pace of exports was far below. An outright decrease in the deficit for this quarter seems likely, and that will offset some of the drain on real GDP growth expected to result from a slower rate of inventory growth.
Companies managed to make money last quarter, but the quality of those profits was low. Rising inventory values, partly the result of the inventory surge, accounted for nearly all of the first-quarter gain in book profits. Earnings before taxes rose $11.2 billion. However, after adjusting for inventory inflation and the differences between tax and replacement-cost accounting, operating profits rose a scant $3.7 billion.
Profits in the second quarter should get a lift from faster economic growth, but one source of profit growth may well be waning. Profit margins, in a steady rise since mid-1991, fell in the first quarter. The drop was the steepest since the recession began more than two years ago (chart). Although margins remain high, reflecting past cost-cutting, the first-quarter decline suggests that companies will have to depend more on price and volume increases for higher earnings in the quarters ahead.
The outlook for profits--as well as for overall GDP growth--continues to rest with consumers. For April, at least, the news is good. Consumer spending rose 1%, or by a healthy 0.7% after inflation. The April advance means that real consumer purchases started this quarter 2% above their first-quarter average, at an annual rate.
Will consumers maintain this momentum? The best sign comes from the housing sector. Sales of new single-family homes skyrocketed by 22.7% in April, to an annual rate of 751,000--the highest pace in six years (chart).
The surge in home buying means that many more consumers will be shopping for appliances, furniture, and other home goods. And because the inventory of unsold homes is extremely low, homebuilding should pick up as well, providing some lift to GDP growth this summer.
However, the dark cloud over consumers is poor income growth. Personal income was flat in April and fell by 0.4% when adjusted for taxes and inflation. Real aftertax earnings began the quarter below the first-quarter level. And the savings rate dropped to 4.3% in April, from 5.3% in March.
Consumer spending can't outpace pay gains for very long. So as always, job growth remains the key to filling consumers' wallets and raising the economy's pulse.
The rebound in consumer demand, though, will inevitably spur more import growth. That inflow will not only hamper economic growth this year. It also complicates trade policy. But instead of blaming Japan for the wider U.S. trade gap, trade negotiators in Washington should probably point a finger at Americans' growing appetite for imports as well. To paraphrase Shakespeare: The fault is not in our trading partners, but in ourselves.