The U.S. Trade Deficit Once Again

Dan Altman writes a good article on America's trade deficit:

A Stickier Trade Gap - New York Times: By DANIEL ALTMAN

Last year was the eighth in a row with a record-setting deficit in the nation's current account.... Yet once upon a time, that big deficit turned around, and it took a mere five years.... From 1987 to 1991, the annual current account deficit fell from a peak of almost $161 billion--equivalent to about 3 percent of the domestic economy--to less than $3 billion. This time, however, the challenge is bigger: the deficit of $805 billion for 2005 was about 6 percent of the domestic economy. And there are other factors that could make a turnaround much more difficult.

First, consider what took place in the late 1980's and early 1990's. The dollar was falling rapidly against foreign currencies, partly as a result of coordination by the governments of the world's five biggest economies. As the dollar fell, American investments became less attractive to foreign investors; the same returns would be worth less when converted into their home currencies. The returns themselves were falling, too.... But even if exchange rates change with the euro and Japanese yen, it probably won't solve the problem the way it did from 1987 to 1991. The big difference is the "changing shares of who we import from, and very few changes in who we export to," said Catherine L. Mann, a senior fellow at the Institute for International Economics, a research group in Washington. "It's important, because who we import from increasingly is from countries that have exchange rates that have not moved very much."

Back in 1987, the nation's current account deficit with Japan and Europe, which had fairly flexible currencies, was 62 percent of the total deficit. Last year, it was just 32 percent.... These changes matter, because countries like China protect their currency links by keeping plenty of dollar-denominated securities in reserve in their central banks. Private investors help out, too, and all those purchases of American securities keep the dollar's value relatively high. When the dollar's value drops relative to the euro and the yen, its exchange rates with the Chinese yuan and a bevy of other currencies don't follow suit.

Moreover, even if the economies of Europe and Japan picked up sharply, it might not help American exports as in the late 1980's. "Today, a really big boom for them is a lot smaller, because they've just slowed down so much in terms of their average growth rates," Ms. Mann said....

"The U.S. capital markets are where people want to invest their money right now," Professor Hodrick said, "and the performance of our economy has been really extraordinary, so there's no reason to think that that's a bad idea."...

Hodrick simply has not looked at the capital inflow data closely: there's little reason to think that true private capital flows to America are large right now. Dan should have probed more deeply--and brought up somebody like Marty Feldstein to rebut.

Me? I still think that a soft landing for the U.S.--either a gradual shrinkage of the deficit or a sharper move triggered not by U.S. macroeconomic distress but by a burst of inflation in Asia--is more likely than a hard landing. But we are well into the danger zone, and getting further in with each passing day.

Comments

[China Law Blog]

Nice, thoughtful post. I do see our deficit with China shrinking as China becomes more of a consumer and starts buying more of what we are making over there (with us getting the profits). But, I agree we have a lot of ground to cover and I certainly am not confident we will be able to do so any time soon.

[spencer]

Given the size of the differences between real imports and exports to get a gradual improvement in the deficit you have to have a scenario where exports grow twice as fast as imports to get a soft landing.

It is extremely difficult for me to envision a "soft" landing that generates those growth rates for imports and exports.

[piotr]

I am an economic ignorant, but to me it seems that we are softly landing in a quagmire.

The way I see it, Europe, Canada etc. just does not absorb much of outside investments, having a rough balance of savings and spending. So mercantilist countries have basically only one place to park their trillions, and that is USA (one can perhaps add UK, Australia and some smaller fry). The only alternative that they may have is their own internal market, so the current situation may last until China develops efficient mechanisms of promoting domestic consumption.

The question is whether we will have enough of manufacturing capacity at that point to get out of the quagmire. It is also possible that American consumers will notice that they have too much debt and that we will enter a spiral of decreasing demand that even zero interest rates will not stop. That would be "hard landing". I just do not understand how we can have "an orderly transition" at all.

[Steve O'Keefe]

Bill Bonner and Addison Wiggin, the team behind the popular
contrarian financial newsletter, The Daily Reckoning, have a new book
out called "Empire of Debt" that predicts a collapse of the U.S.
economy due to a combination of our trade deficit, national debt,
consumer debt, and the bottomline fact that we can't continue to
spend more than we earn -- as individuals or as a nation -- without
someday having to settle up. There's a harsh excerpt from the book at

http://tinyurl.com/nbd8d

[kevin quinn]

Department of 'Huh?'

In the quoted material, it is claimed "the falling dollar makes US investments less attractive to foreigners" --huh? If a fall to a a lower permanent level, the desire to invest is not affected - the rate of return is unchanged. It costs less foreign currency to buy the assets and they provide lower foreign currency returns. On the other hand, if it is a *temporary* fall in the dollar the inducement to invest in the US is greater in virtue of the expected appreciation that will occur when the dollar returns to its higher level. My students usually get this wrong in the other direction, imagining that a lower permanent value of the dollar makes investments more attractive. A permanent change in the value of the dollar has *no* effect on the inducemtn to invest in US assets.

[anne]

The reference is to a persisting decline in the value of the dollar, and a resulting reluctance to invest here while further decline was anticipated. The Plaza Accord of 1985 changed expectations about the dollar that Europeans caught early on while the Japanese were misled on.

[anne]

Though the Plaza Accord has been taken for a success I do not agree, thinking the relative sustained and sharp loss in value of the dollar skewed investment decisions as well as short term money flows in what would be damaging ways in Europe and Japan and America over the subsequent decade.

[ob]

The model that has China ramping up imports of US goods seems to assume that we have things they want and can buy. They don't really respect IP, so Hollywood is out. Congress won't allow them to buy technologies or natural resources. And we are working as hard as we can to get rid of "old economy" manufacturing here at home. Most service industries seem to rely on locality or intellectual property.

I guess they can start buying shares of corporations through intermediaries in Bermuda, and I can start boning up on Mandarin.

So I see the only possible outcome a "natural" currency revaluation. But who knows, when it comes to economic predictions, I always find new capacity for being wrong.

[RKKA]

I agree that its a mystery why China should increase imports of US goods any time soon, when collossal capacity to produce goods is what China has now.