U.S.: As The Trade Deficit Shrinks, A Plus For Growth
The narrowing U.S. trade deficit could give a lift to economic growth in 2007 for the first time in a dozen years. Surging exports and slower growth in imports reduced foreign trade's drag on the economy to virtually zilch in 2006, and the primary factors that led to the improvement last year are still in place. Most notably, strong global economic expansion and a softer U.S. dollar should keep exporters busy, while weaker domestic demand in the U.S. holds down the appetite for imports.
Indeed, the global economy is managing quite well without the U.S. leading the charge. According to the latest semiannual economic forecast from the International Monetary Fund, world economic growth should be 4.9% this year, compared with 2.2% for the U.S. What's more, global growth should be balanced, with key U.S. trading partners such as the euro zone, Japan, and Canada expected to fare well this year.
The U.S. Census Bureau's February foreign-trade data did show an increased risk that trade will pose a small drag on the economy in the first quarter. Adjusted for changes in import and export prices, the merchandise trade deficit widened a bit.
But the February results are no cause for alarm. Without adjusting for price changes, the trade gap narrowed to $58.4 billion as a drop in imports, driven by lower oil prices, more than covered a one-month $2.8 billion decline in exports. In addition, many economists who are forecasting that trade will be a plus to economic growth this year also expected a slight setback in the first quarter. That isn't a shocker considering the surprising performance in the fourth quarter, when trade accounted for nearly two-thirds of the 2.5% annualized gain in real gross domestic product.
THE FUNDAMENTALS SUPPORT a solid rebound in exports during the coming months. For starters, a weaker dollar is providing a competitive boost. Since early 2002, the greenback has fallen nearly 30% against a trade-weighted basket of major currencies such as the euro and yen (but excluding the yuan). A declining dollar reduces the prices of goods or services in foreign-currency terms. This allows U.S. companies to gain precious market share just by holding prices steady in dollar terms.
Further declines in the dollar appear likely. The divergence in global and U.S. growth will probably mean foreign central banks, particularly the European Central Bank and Bank of England, will raise interest rates while the Federal Reserve stays on hold. Diversification of foreign reserves among developing and oil-producing nations into other currencies and assets could also exert some downward pressure on the greenback.
More important for U.S. manufacturers, however, is the continued strength in foreign capital spending. Global economic growth has been no slower than 4.9% in the past three years. This sustained level of strong economic expansion soaked up a lot of excess capacity. Many factories abroad are operating flat out. In the euro zone the capacity utilization rate climbed to 84.4% in the first quarter, the highest level since 2000. In Japan, the utilization rate hit a more-than-15-year high in December. But the limits in capacity extend beyond manufacturers, as the demand for commodities by China and other countries is straining the infrastructures of resource-rich nations such as Australia and Brazil.
The need to build new factories, expand ports, and pave more roads means increased demand for capital equipment, which is likely to be good news for U.S. makers of big ticket items such as construction equipment and other capital goods. The March industrial production data showed capital-goods makers were busier. And the March reading on export orders by the Institute for Supply Management improved.
Expanding businesses overseas are also hiring workers, which is leading to tighter labor markets and improved domestic demand. Around the world, consumer spending is rising, helping to drive demand for U.S. consumer goods. Exports of consumer goods are on a tear, up 13.3% from a year ago in February.
WHILE THE PICTURE for exports looks good, slower import growth will ultimately determine whether the trade balance provides some support to U.S. economic expansion. To understand why, just look at the numbers. Imports of goods and services were nearly 1 1/2 times as large as exports in 2006. That means in order for the trade gap to narrow, exports must grow more than 50% faster than imports.
Import growth has been moving in the right direction. In the year ended in February, imports of goods, adjusted for inflation, are up only 2.6%. That's down from a 8.9% growth rate in the year ended in August, 2006. The outlook for subdued growth in imports remains favorable. The housing recession and growing caution among businesses with regard to domestic investment plans should ease demand for foreign capital goods and industrial supplies.
U.S. purchases of foreign-made consumer goods are what merit the most attention now. On the surface, the March retail sales report showed continued strength in consumer spending, but a 3.1% jump in gasoline sales, due to higher pump prices, implies that consumers are experiencing a decline in purchasing power. If gas climbs above $3 per gallon nationwide, and stays there a while, it will probably cool down imports of consumer goods.
ALTHOUGH THE STARS are currently aligned for an improving trade balance this year, risks still exist. On the export side, protectionist urges could backfire. As the Presidential election season heats up, campaign rhetoric and political pressure to level additional tariffs and duties on China will probably grow. But politicians know such actions would run the risk of retaliatory measures by Beijing just as China is growing in importance as an export market. In 2006, exports to China grew by 31.7%, to $55.2 billion, making it the No. 4 destination for U.S. exports.
Chances for a narrower trade deficit this year would also take a hit if the U.S. economy does better than expected. That's because imports are directly linked to the health of business investment and consumer spending. Given the trade math, it wouldn't take much of an acceleration in imports to offset a strong gain in exports.
Right now, U.S. economic growth is widely expected to improve gradually during the course of the year as the drag from housing diminishes. However, a quicker revival in the U.S. economy that would lead to another widening in the trade gap would certainly outweigh any potential boost that trade could provide.
Even if all does go as expected this year and the trade balance narrows, making additional progress won't be easy. It will be awfully hard for exports to consistently outpace imports by the huge margin needed. But the latest signs that the global economy may be less dependent on the U.S. as the primary engine of growth does offer hope.
By James Mehring