U.S.: Finally, Relief From The Trade Deficit
Don't look now, but there might be some good news on the way to replace the perennial downbeat reports on the U.S. trade deficit. Coming on the heels of July's record gap of $68 billion, that assertion may sound foolhardy. But several domestic, overseas, and financial market forces are coming together in a way that is turning the tide, and the shift will directly benefit economic growth.
In fact, when viewed properly, with both imports and exports adjusted for price changes, the deficit already shows signs of stabilizing. That's important, because as this adjusted gap widens, it subtracts from economic growth, as it has done in each of the past 10 years. Just stopping the erosion will eliminate an obstacle in the economy's path, and any shrinkage would be an outright plus for growth.
As the July trade data show, any expectation of dramatic improvement would be a pipe dream. Perhaps the biggest obstacle in the way of significant progress on the deficit is the math of U.S. trade. Partly reflecting globalization and the openness of the U.S. economy, price-adjusted imports -- or in the economist's vernacular, real imports -- have more than doubled in the past decade, while real exports have grown only by a half. That means exports have to grow 50% faster than imports just to keep the deficit from widening further.
Since the end of last year, exports have more than met that challenge. From the fourth quarter of last year through this year's second quarter, real exports of goods and services grew at a 9.4% annual rate, double the 4.7% pace for real imports. In the first quarter, the trade deficit, after taking prices into account, posed no drag at all on growth in real gross domestic product, and it shrank in the second quarter, adding 0.4 percentage points to that quarter's 2.9% advance in real GDP. The July trade numbers suggest the deficit could subtract a bit from third-quarter growth, but the sharp monthly widening runs counter to the more favorable price-adjusted trend.
TWO MAIN FACTORS are behind that improving pattern. First, growth outside the U.S. is picking up even as American growth is easing back a notch. That's one reason real exports have picked up, while real imports have slowed. Oil shows the importance of looking at price-adjusted imports. Crude prices have soared, pushing up the dollar values of both oil imports and total imports, but the actual number of barrels of imported petroleum products is up very little from two years ago.
The second big reason for optimism on trade is the broad decline in the dollar. The slippage began in early 2002 and has resumed this year after a period of strengthening last year. The lower dollar represents a de facto rise in the competitiveness of American products in overseas markets. U.S. exports are now in a position to gain market share abroad, most notably in high-tech capital goods and a broad array of business services, such as financial and legal. The latest numbers imply they are doing just that.
The good news on the dollar is not confined to the major U.S. trading partners. For two years, the trade-weighted dollar has been declining against a group of 19 smaller, but important, partners. This dollar index, compiled by the Federal Reserve, includes China and other Asian economies, key Latin American nations, and other countries accounting for about 40% of U.S. trade. Many want to keep their currencies in a narrow band vs. the dollar to maintain their competitiveness. But this index has declined 6.7% from its peak more than two years ago, to the benefit of U.S. exporters. China's small steps toward a more flexible currency has been partly responsible for this trend.
WHILE THESE TWO PLUSES will continue to aid the U.S. trade adjustment in the coming year, it is the shifting trends in global demand that will be far more important than changing currency relationships. Stronger foreign demand will give recent U.S. export gains their staying power, because the acceleration in overseas growth has firmer roots than in past upturns.
Unlike other short-lived periods of growth in economies abroad, this pickup is not so much driven by exports, especially to the U.S. This time it is also powered by stronger domestic demand in the individual countries. So even if demand in the U.S. slows a notch as the housing recession works its way through the economy, growth abroad is not as dependent on the U.S. to lead the global growth parade as it has been over the past several years.
Both Japan and Germany, where private-sector consumption spending and business outlays for capital goods are picking up, are good examples. In both countries, unemployment is down, wages are picking up, and profits are growing. The euro zone's solid 3.6% growth rate in the second-quarter showed a sizable contribution from domestic demand. Over the past year, homegrown spending in both Mexico and Canada, which together take 36% of U.S. exports, is increasing faster than in the U.S., and a similar story is true in many of the Pacific Rim economies.
AGAINST THAT BACKDROP, U.S. export gains have been broad across all sectors and regions. Capital goods are leading the charge. Strengthening internal demand in overseas economies is boosting capital spending plans of foreign companies. That trend plays right to a U.S. strength. In the first seven months of 2006, price-adjusted exports of capital goods are up more than 14% from the same period in 2005. Big gainers are computers and accessories, semiconductors, telecom gear, electric items, as well as lower-tech machinery and generators.
During the first seven months of 2006, U.S. exports to Canada and Mexico are up about 12% from the same period last year, not adjusted for prices since such data are not available in the monthly trade report. Shipments to the European Union also have risen about 12%, with demand from Pacific Rim countries up 14% and that from South and Central America up nearly 19%. Exports to OPEC countries are also soaring, up 30%, as petrodollars get recycled back into purchases of U.S. goods.
Looking ahead, a key support under foreign demand continues to be easy global financial conditions. Interest rates outside the U.S. are rising but remain low. In both Japan and the euro zone, central-bank policy rates, adjusted for inflation, are still well below that in the U.S. Relatively narrow risk spreads between the yields on government securities and riskier corporate bonds indicate accommodative borrowing conditions across the globe. And most recently, the sudden dive in oil and energy prices will further boost corporate and household confidence as well as purchasing power in a broad array of energy-consuming economies.
In each of the four full years of this economic expansion, a widening trade deficit has subtracted anywhere from 0.3 to 0.7 percentage points from overall growth. Clearly the gap is going to remain at a daunting level for some time to come. But 2006 might well be the first year in a decade that trade stops being a drag on economic growth.
By James C. Cooper