U.S.: When A Wider Trade Gap is A Good Thing
Nervous investors and traders were watching intently on June 15 when Washington released May's consumer price index. Earlier data looked worrisome, fueling concern that the Federal Reserve might have to raise interest rates more than expected. However, the May numbers inspired a collective sigh of relief. True, soaring energy costs boosted the overall index by 0.6% from April, but the more important core index, which excludes the ups and downs in energy and food in order to give a better reading of inflation's underlying trend, rose a tame 0.2%, right on expectations.
Perhaps the skittish folks on Wall Street should have paid more attention to the report released a day before: Foreign trade data showed that the April trade gap widened to a record $48 billion, far larger than anticipated. Imports jumped another 0.2% after two huge gains in February and March. That uptrend is a big plus for the price outlook because fierce global competition will help to limit -- although not negate -- the rise in pricing power among American companies this year.
Given that nearly 30 cents of every dollar spent on nonoil goods goes to imports, up from about 20 cents in the early 1990s, the rise in demand is attracting imports at an accelerated pace. Since the economy started to pick up steam last summer, exports have grown by a respectable $8.3 billion, but imports have surged by $15.8 billion.
Consumers in particular have been spending freely, and their purchases of cheap imports help to stretch the buying power of their paychecks. In May, retail sales jumped 1.2%, and they were up 8.9% from a year ago. In the past year, consumer goods and autos have accounted for half the overall advance in imports.
To be sure, the inflation-friendly forces most often cited in the outlook are strong productivity and the slack still present in production capacity and the labor markets. However, the global economy is a critical force pushing businesses to become more productive and to find cheaper places to produce goods and services. Of course, these overseas production moves are why foreign trade is also connected to job security in the U.S. Taken on the whole, global competition is, and will continue to be, a powerful restraint on inflation.
POLICYMAKERS AT THE FED still don't appear overly worried about inflation. Fed Chairman Alan Greenspan took the opportunity at his June 15 confirmation hearings to discuss prices and monetary policy. He said "our general view is that inflationary pressures are not likely to be a serious concern in the period ahead." He went on to reiterate that the Fed's moves to reduce the current amount of stimulus in the economy are "very likely to be measured." While the Fed chief left the door open for a faster pace of tightening if their forecasts prove wrong, his testimony indicated that policymakers will lift interest rates at a pace that won't disrupt the markets or the economy.
The Fed can take a benign view of inflation because the recent jumps in the price indexes have come mainly from one source: energy. Gas and fuel prices have had a sizable impact on the consumer price index. In the 12 months ended in May, total inflation ran at a 3.1% pace, up from 1.9% for all of 2003. In the first five months of 2004, the CPI rose at an annual rate of 5.1%.
Yearly core inflation, however, held at only 1.7% in May, the same as April. That is hardly a number policymakers will get excited about. That's especially true given that the Fed's preferred inflation measure, the price index for personal-consumption expenditures excluding energy and food, shows yearly inflation at only 1.4% in April. The Fed believes the PCE index gauges the cost of living better than the CPI, since it captures more shifts in buying patterns when some prices rise more than others.
OUTSIDE OF ENERGY, some of the price increases in recent months, especially at the producer level, have reflected the pass-through of spiking commodity costs. They will prove temporary because materials prices generally have peaked, and many are falling.
Cost pressures in the supply chain will also get a break when U.S. manufacturers help to relieve them by boosting output to a level that is more in line with the current high pace of demand. In May, industrial production rose 1.1%, on top of a 0.8% gain in April. So far this year, output is growing at an 8.3% annual rate, a sharp speedup from the 2.3% growth rate for all of 2003.
Even at that quick pace, manufacturers are still playing catch-up. In April, overall business inventories rose 0.5% from March, but the ratio of inventories to sales stayed at its record low of 1.30. The lack of progress can be traced to booming demand. Even though inventory growth has picked up sharply, to an annual rate of 7% so far this year, sales are growing at double that rate.
Consequently, news from the nation's purchasing managers suggests the distribution system is under such strain that some producers have the power to lift prices. But when inventories realign with demand and when supply bottlenecks clear, some of that will diminish.
That's a big reason why imports will be a saving force for price trends. Increases in foreign-made goods take the pressure off of the U.S. distribution chain by satisfying more demand than American producers could on their own and by helping inventories to be rebuilt.
INTERESTINGLY, the decline in the dollar, which should be lifting import prices, is not having much impact. Part of the explanation is that, by any measure, the dollar remains very strong. The trade-weighted greenback fell 13% from early 2002 to January, 2004, but through May the dollar has turned up, regaining 4%. Today's reading is equal to those in the late 1990s, when the dollar was valued more than 50% above its level in the early 1990s.
Plus, as with other price measures, much of the rise in import prices stems from the jump in commodity prices. Over the past year, import inflation, excluding petroleum, has accelerated to 3%, from 0.7% a year ago. But prices of nonoil materials and supplies, up 14.7% from a year ago, accounted for 2.4 percentage points of the 3% rise. Prices of consumer goods, not including autos, are up only 0.6%, while prices of capital goods have fallen 1%.
The factor at work here is the managed-exchange-rate policies of many Asian nations, especially China, where currencies are pegged to move in tandem with the dollar. Through April, imports from China are up 26% from the same period a year ago, accounting for 22% of the total increase in U.S. imports. Among Asia's newly industrializing countries, such as Taiwan and Singapore, import prices are actually down 0.3% from a year ago. Even if China revalues its currency, the appreciation probably won't be enough to affect U.S. inflation.
That's because American consumers and businesses have learned to take advantage of the growing global marketplace. They are buying goods and services at the best price from the best source. This international bargain bazaar is the reason why inflation forces generated in the U.S. won't gain traction anytime soon.
By James C. Cooper & Kathleen Madigan