March 10, 2006
The downward march of the trade balanceSome context for the the latest trade deficit numbers
Yesterday's trade deficit exceeded expectations, yet again. The Bloomberg consensus was for a -$66.5 billion dollar deficit. The actual reading was -$68.5 billion, or a 3% surprise. Now it is important to recall that there is a lot of noise in these trade figures. The standard deviation of the trade balance numbers over the past two years is $6.7 billion, so a $2 billion monthly surprise is not a statistically significant outcome (although $24 on an annualized basis is a big number even when compared against the annual U.S trade balance).
On the other hand, as pointed out by others (see Brad Setser), the picture painted by these numbers reinforces the view that there is no imminent stabilization of the trade deficit at hand. In the figure below, I have normalized the trade balance by the interpolated GDP series (I have assumed 8% nominal growth in GDP in 2006q1, in line with Deutsche Bank's forecast).
Trade Balance (Balance of Payments basis) to interpolated GDP ratio. Source: BEA, Census, and author's calculations.
A glance at the export and import series confirms that the rise in imports -- even excluding oil imports -- is outpacing the growth in exports.
Exports and Imports (total, ex. oil) in billions of dollars, seasonally adjusted.
This trend in exports occurred despite fairly rapid growth in world GDP in 2005q4, as illustrated in the following figure.
Source: Economist, March 2, 2006
What will growth in 2006 look like, with US, euro area and Japanese policy rates rising? The Economist survey in the March 9th issue indicates that 2006 Japanese growth will be roughly the same as recorded in 2005, a slight acceleration of growth in the euro area to 1.9% from 1.4 in 2005. So, one should probably not look to the rest of the world for an enormous boost to exports.
What is the real news here. In some ways, it is the context of the downard march in the trade deficit that is important. As the Economic Report of the President, 2006 pointed out, the private financial account and the official financial account (what is sometimes called official reserves transactions) must balance out the current account deficit (see my discussion here). Up until now, that has been easily accomplished, with a good chunk of the financing coming from the official sector (read foreign monetary authorities). With the Dubai Ports World deal now thrown into a state of flux, one has to wonder what terms the rest of the world -- the monetary authorities, private investors, and quasi-state entities -- will want to lend to the U.S. More savings into Treasuries rather than into physical assets? Or an increased aversion to all U.S. assets (see my colleague Jim Hamilton's early post on that question)? That is the $822 (= $62.5 x 12) billion question.
Posted by Menzie Chinn at March 10, 2006 07:05 AMdigg this | reddit
Dr. Chinn, prospects for a Noughties-style Plaza accord to address growing imbalances are not in sight. As Roubini and Setser point out, unlike in the 80s, the US needs to deal with political and economic (read: non G-7) rivals. In the lack of prospects for cooperation, there is only one real way to slow down growth of external deficits: reduce consumer spending on imports.
I think that the Fed might be trying to do just that by raising the Fed funds rate all the way to 5.0% or beyond (though James Hamilton will disagree). Your intuition that foreigners might not want to fund the deficit anymore as Uncle Sam insists on giving them a raw deal is probably correct. TICS data last month showed that the shortfall wasn't made up for, so next week's data will be interesting. The spigot of automatic financing might be coming to a close if a trend emerges.
Posted by: Emmanuel at March 10, 2006 09:08 AM
Emmanuel - if the FED continues to raise rates it will do two things: (1) stifle all demand not import demand & (2) strengthen the dollar by increasing the reward for offshore money to invest in USD debt... continuing to make imports cheap & exports dear & doing little to change the ratio of the two by much... some maybe but not much.
So I don't see how the FED alone can choke this thing off with out chocking the whole economy to death.
Am I missing something?
Posted by: dryfly at March 10, 2006 11:36 AM
Well, we have created this mess. Dubai does not play by our rules. It has absolutely no complaints on that score. Private investors are not allowed to hold majority stock in a Dubai company.
But, they have the bucks now—very big bucks. As Movie Guy pointed out, ISS is a very interesting Dubai company. While Congress got in a roar about IBM PC, Dubai was busy where the real action is: Cutting edge IT. But Congress is too busy playing its political power games to be interested in what precisely is happening. Besides, short term economic interests trump everything.
Globalization is being played with two different sets of rules: One for democracies and quite another for dictatorships. (“Quasi-state entities” is far too generous a term.) And, as the generous terms of the DP World/P&O deal reveal, turning an immediate profit may not be all that DP World/Dubai had in mind. I have to hand it to them: They are keeping their eye on the prize. Control a world-class asset. Rest assured, American financiers and know-how will do everything they can to help you. And float that very nice Sukuk bond.
Setting aside the Dubai ports deal—which is merely one foreign company selling to another--, I would note that selling American assets does nothing to lower our debt or reduce our trade deficit. If anything, the selling makes matters worse. Nor does allowing our corporations to seek tax havens in Ireland or Bermuda help us. And, yes, offshoring is the game de jour: labor arbitrage, tax arbitrage, and environmental arbitrage.
As our corporations reach for the brass ring under rules we have tacitly or openly, but foolishly, endorsed, the homeboys will be paying the price. The American citizen will be left holding the bill.
Posted by: Stormy at March 10, 2006 12:07 PM
Dryfly, my argument is hinged on US creditors becoming more reluctant to fund the deficit because of economic and political reasons. Even if yields go up somewhat on Treasuries, I believe that they would rather own more tangible American assets. See Nouriel Roubini's post on this issue.
The US risks alienating its creditors by saying that they can (should?) buy as much relatively low-yielding official debt as they want while limiting purchases of more productive assets. From a recent Reuters article on the ports debacle, the choice line is this one: Gulf Arabs reacted bitterly on Friday to Dubai's decision to relinquish control of six U.S. ports, saying the political storm that forced the emirate's hand could provoke a backlash among regional investors.
Posted by: Emmanuel at March 10, 2006 03:38 PM
Emmanuel and dryfly,
I am not worried that the Dubai fiasco will so pique foreign interests that they will take all their money and go home. They are big boys. Money goes where profit is. If they think T-bills are a good investment, they will use them. Since when did any investor pass up a good investment simply because he was denied a better? The fear argument that is being floated is for children by those who have skin in the game.
Besides, as I pointed out, Dubai is not exactly a free enterprise country. Dubai prohibits any foreign interest from having a controlling interest in any Dubai company. It protects its own. How often this little fact is forgotten. Please see:
I think it is high time for all of us to become fully acquainted with Dubai business practices. The idea that free capitalism flourishes in Dubai is a joke. That is not to say that money cannot be made in Dubai. It certainly can be made.
I think if we think real hard, we can certainly understand the ulterior motives of those who claim that Congressional reaction to the port deal was a big mistake. I really am amazed that few have been able to penetrate this PR fog, economists included.
Meanwhile, we are left with a mess. The Fed raises the rates, the economy chokes, and paradoxically, foreign banks buy even more of our debt. Selling off assets is no solution. Debt remains. We can hope for revaluation, but that addresses only China, if that.
The only solution is to take our medicine now or later.
Posted by: Stormy at March 10, 2006 09:00 PM
It is interesting that we are all so used now to the strong central bank role that the "traditional" remedy for the U.S. situation has not been mooted - double digit inflation and concommitent growth of the money supply for say three to five years.
The advantages are clear. The real value of the external debt would drop by half. Tax revenues would soar, probably resulting in a much better looking Federal deficit. The pension plan woes of the old defined benefit companies would disappear, and Ford and GM wouldn't need to go Chapter 11. Taxpayers would, at least initially, be happy as the face value of paycheques would rise, and dollar illusion would make them feel richer.
Of course in the long run, this cure is worse than the disease, as the experience of the late '70s and early '80s suggests. That doesn't mean that a desperate White House might not be tempted to try it.
Posted by: David Baskin at March 11, 2006 06:06 AM
In the lack of prospects for cooperation, there is only one real way to slow down growth of external deficits: reduce consumer spending on imports.
Or the flip side, create a booming export market that exchanges those tbills/corp debt for genuine American Bamboo Housing.[It could happen. We have the resources. And the technology. And the mostly empty ships going East, just waiting.]
The costs of the war are ignored here (and don't forget Homeland Security).
Reduce spending on war and war measures might help. [It could never happen. We don't have the resources. The world is too dangerous.]
Posted by: calmo at March 11, 2006 06:44 PM
While I believe it would be a macroeconomically reasonable solution, how palatable would double digit inflation be to the AARP and their lobbyists in Washington, with too many retirees and soon-to-be baby boomer retirees on fixed or quazi-fixed incomes. It is too easy to rest the problem on the shoulders of their grandchildren.
The consumption that has occurred in the last twenty years has not only created the existing problem, but has made the proper solution politically unfeasible. The prospect of further entitlement spending for those who failed to adequately plan for their retirement merely complicates any proposed debt reduction approach.
We need to educate the population that there is no free ride and that it is time to stop buying 42 inch plasma tv?s with borrowed money. I only hope that some leadership emerges that has the intestinal fortitude to actually call it as it is.
Posted by: Eric Salant at March 12, 2006 06:42 AM
Menzie -- "Yesterday's trade deficit exceeded expectations, yet again. The Bloomberg consensus was for a -$66.5 billion dollar deficit. The actual reading was -$68.5 billion, or a 3% surprise. ..."
"On the other hand, as pointed out by others (see Brad Setser), the picture painted by these numbers reinforces the view that there is no imminent stabilization of the trade deficit at hand."
We're not anywhere near stabilization of the trade deficit. It's not within reach under existing U.S. trade policies, U.S. tax policies, WTO trade policies, and global currency valuation governing mechanisms.
As more goods, finished products, and components are sourced abroad for the U.S. consumer and business markets, the range of products imported will continue to grow. Period. While the volume will fluctuate up and down based on economic cycle conditions, the foreign source issue remains front and center. If you don't manufacture or grow it here, then you import it. The more you manufacture, assemble, grow, and mine abroad as primary or sole sources for such goods, the more you import.
Another wave of foreign-source automobiles is next on the list. And more automobile parts and component suppliers are going offshore. Wait until we see those additional trade deficit numbers.
We're not going to reduce consumer and business share expenditures on imports under the present policies and rules. For a growing number of finished consumer and business goods, the only providers are foreign-based sources.
More, not fewer, U.S. and European businesses are setting up operations in Asia and elsewhere to support domestic and foreign consumption needs. The plant and sourcing investment trends continue unabated.
Meanwhile, U.S. exports are showing healthy growth, but U.S. market share abroad is declining in all seven major global trading regions.
U.S. exports, absent new closely held proprietary technologies and end products, will not routinely exceed U.S. imports. It's just not going to happen.
The U.S. is importing too many types of goods to support the domestic market for there to be a realistic expectation that the trade deficits will stabilize or reverse. Many of these products are no longer available from U.S. domestic-source operations.
It's Economic Hydrology Theory. We've opened the floodgates and tore out some of the dams. Game on.
Economists and businessmen wanted it. They got it.
Posted by: Movie Guy at March 12, 2006 03:44 PM
"With the Dubai Ports World deal now thrown into a state of flux, one has to wonder what terms the rest of the world -- the monetary authorities, private investors, and quasi-state entities -- will want to lend to the U.S. More savings into Treasuries rather than into physical assets? Or an increased aversion to all U.S. assets (see my colleague Jim Hamilton's early post on that question)? That is the $822 (= $62.5 x 12) billion question."
Ah, the fear factor. Well, let's see. Goods, services, crude oil, precious metals, and other resources are purchased abroad. Right? We pay U.S. dollars. Right? The foreign interests now have the U.S. dollars. Right? What are they going to do with the U.S. dollars, if not roundtrip them back to the USA directly or indirectly? Eventually, the U.S. dollars come back unless the foreign interests intend to hold them and not earn anything on the hold. There is no advantage in holding U.S. dollars beyond anticipated reserve needs. So, they come back to the USA.
Unless foreign interests refuse to accept payment in U.S. dollars, we do not have a problem. In fact, the inability of foreign interests to purchase critical U.S. infrastructure frees up more roundtrip dollars and other foreign-source investment for other commercial U.S.-based activities and entities. Moreover, surplus of additional U.S. dollars not invested in available U.S. commercial offerings and assets will serve to drive down the yield on U.S. Treasuries.
Posted by: Movie Guy at March 12, 2006 03:48 PM