What's Really Feeding The Trade Deficit Beast
By Robert Kuttner
The U.S. trade deficit will exceed 5% of gross domestic product this year. A big trade deficit, combined with a low domestic savings rate, requires the U.S. to borrow heavily from abroad. We currently owe the world about 40% of one year's GDP -- $4 trillion, something totally unprecedented. That figure will keep rising, with more of our own income going to service external debt. At some point, our creditors will have second thoughts. For two decades, economists have warned about the unsustainable trade deficit. To paraphrase the late economist Herb Stein, anything unsustainable won't be sustained. But will the rebalancing be a soft landing or a painful crash?
I fear the landing could be nasty, but I disagree with most economists who blame the problem on our budget deficit, savings rate, and overvalued dollar. Look more carefully and you'll see three deeper structural causes, all related to hegemony and ideology.
First, America's geopolitical dominance causes our leaders to subordinate the trade problem to the high politics of war and peace, while other nations put economic goals first. This is truer than ever under George W. Bush. As the China talks illustrate, we would rather have Beijing's support on the Korea crisis than insist that China let its currency float.
Second, as prime sponsor of the free-trade system, the U.S. is often indifferent to the status of its own exports within that system. Washington periodically (but inconsistently) goes to bat for politically important industries, like steel, or fights for intellectual-property rights prized by filmmakers or drugmakers. But more than any other trading nation, it doesn't much care where production is located. When Wal-Mart Stores Inc. (WMT ) imports most of its goods or Intel Corp. (INTC ) produces most of its microprocessors offshore, that's great for the company's bottom line. But it contributes to a trade imbalance that has become structural. The U.S., as sponsor of liberalized trade, also promotes deals like NAFTA, which benefit the trading partner's exporters more than American ones.
This penchant has intensified under Bush. The President fought hard to get China into the WTO, but he neglected to insist on Chinese policy changes in advance, while U.S. negotiators had the leverage. The U.S. Commerce Dept., unlike its French, German, Chinese, or Japanese counterparts, actually promotes U.S. offshore production and investment.
Third, our view of trade is hobbled by mistaken economic theory. Most economists discount structural factors. In standard theory, the trade deficit mainly reflects budget-deficit and exchange-rate fluctuations. The more government borrows, the more capital we have to import. Unfortunately for the theory, the government's budget deficit came steadily down in the mid to late 1990s -- and the trade deficit kept climbing, even right through the recession, when reduced consumption supposedly cuts imports and improves trade balances.
Similarly, a cheaper dollar supposedly helps the trade balance because it changes the relative price of imports and exports. But here again, because so much of the trade deficit is structural, exchange-rate shifts don't produce the predicted gains. The dollar has steadily fallen against the euro and the yen, but the trade imbalance keeps rising. Why? European and Japanese exporters are famous for "pricing to market." That's why the showroom price of Toyotas and Toshibas stays flat. And China, with its immense bilateral imbalance with the U.S., keeps its currency pegged to the dollar, so the greenback's decline doesn't help at all. Until Washington appreciates the structural nature of the trade imbalance and adjusts its policies accordingly, the trade deficit will just deepen.
The U.S. also pays a price for the dollar-dominated global system, which Charles de Gaulle once called America's "exorbitant privilege." It's a devil's bargain: We buy their goods, they finance our deficit. They embrace the idea of free trade, we accept their mercantilism. They take the production that we blithely outsource and we accept the dollars they return to us.
Worst of all, the Bush Administration is addressing neither the structural nor the budgetary sources of the trade crisis. If economists disagree on how much of the trade deficit is structural, they agree on what a hard landing looks like: World financial markets lose confidence in the dollar and stop financing the mounting trade and budget deficits. The dollar goes into free fall and the U.S. economy crashes. It's not a pretty picture. If this is not to be our fate, our leaders need to grasp the real causes of the imbalance and to remedy them.
Robert Kuttner is co-editor of The American Prospect and author of Everything for Sale