Tuesday, July 13, 2010

US Trade Deficit Widens; Ignorant Hysteria Predictably Ensues

The Obama administration today announced May's trade numbers:
The U.S. Census Bureau and the U.S. Bureau of Economic Analysis, through the Department of Commerce, announced today that total May exports of $152.3 billion and imports of $194.5 billion resulted in a goods and services deficit of $42.3 billion, up from $40.3 billion in April, revised. May exports were $3.5 billion more than April exports of $148.7 billion. May imports were $5.5 billion more than April imports of $189.0 billion.
The government's announcement elicited a typical round of very loud worry from the some of country's professional worriersjournalists and economists:
The U.S. trade deficit with the rest of the world surged to $42.3 billion in May, a nearly 5 percent increase over April's numbers that reflects strong growth in imports of cars, computers and clothing, the Commerce Department reported Tuesday morning.

The monthly deficit is at its highest since November 2008. Since bottoming out about a year ago, U.S. exports have put in a strong performance, growing by 21 percent, as U.S.-made shipments of heavy equipment like tractors and airplanes were scooped up by fast-growing developing nations like China and Brazil.

But the solid gains in exports, which helped to revive growth in the overall economy, were not enough to offset a 29 percent surge in imports in the last year.

"Imports are rising much faster than exports, and the overall trade deficit will increase even more sharply when oil prices rebound, threatening the economic recovery," said Peter Morici, business professor at the University of Maryland.

"President Obama has cautioned Americans about the dangers of another boom financed by excessive borrowing. But unless the administration implements policies that reverse the huge trade deficits on oil and with China, the nation risks economic stagnation," he said.

Mr. Obama last year extracted pledges from other global political leaders in the Group of 20 economic powers to seek more balanced growth between nations. But the U.S. economy a year ago resumed its pattern of consuming more goods from the rest of the world than the U.S. is able to produce or to export.

Mr. Morici and other analysts blame that trade imbalance — particularly the gigantic $300 billion yearly trade deficit with China — for helping to cause the credit and housing bubble that led to the 2008 financial crisis and Great Recession. China used its massive earnings from exports to the U.S. to buy U.S. bonds and mortgages, helping to dramatically lower interest rates and feed the bubbles that dragged down the whole world economy when the bubbles collapsed in 2008.

Noting that oil and consumer goods from China account for nearly the entire trade deficit, Mr. Morici said the nation needs a "seismic change in energy and trade policies" to reverse the trend.

But the administration's moratorium on offshore oil drilling will only worsen the deficit, he said, and its diplomatic efforts succeeded in extracting only a mild concession from China last month when it agreed to allow a minor appreciation of its currency, the yuan, against the dollar.
The article admittedly goes on to quote an economist who says that the deficit numbers are - shocking! - a positive sign for the US economy, but it quickly follows that comment with more doom and gloom.   And, of course, those who regularly follow this blog already know the facts about the US trade deficit, particularly the undeniable truth that over the last 20+ years an expanding US trade deficit is strongly correlated with economic growth, not stagnation.  Maybe that's why the stock market didn't implode today and instead rose almost 150 pts (1.44%), causing humorous headlines from other, umm, "misinformed journalists" like this fun one: "Stocks surging on upbeat earnings, shrugging off trade deficit."


But for a moment, let's assume that Mr. Morici is right (he isn't), and that the US government follows his advice and implements protectionist policies attacking imports of consumer goods from China and energy imports from Canada, the Middle East and elsewhere (it won't).  And assuming that such idiocy does't cause the US economy to implode (it might), would these policies actually affect the US trade deficit?

Quick answer: No.

The long answer comes courtesy of Brian Wesbury and Robert Stein of First Trust Advisors in a great article entitled "Trade Deficits As Far As the Eye Can See" (h/t Andy Roth):
The trade deficit peaked at 6% of GDP in 2006. It fell during the recent recession – to about 3% of GDP. While this decline has quieted those who support protectionism, and allowed the Obama Administration to declare that there are no countries manipulating currency values, protectionism is never far from the political front burner.

As the trade deficit increases again in the next few years, and as manufacturing jobs disappear because of productivity increases, protectionism will once again become an issue.

But, this fear about the deficit ignores a major reason for it. Ultimately, the US trade deficit is a by-product of an attractive investment climate. Foreigners, with assets to invest, often need to worry about the risks of exposing those assets to a local banking system that makes ours look like a pillar of strength. Just look at Thailand’s populist upheaval, or the pressure for Greece to abandon the euro and devalue. No wonder central banks and other investors view US investments as preferable, even if investment returns (in dollars) are paltry.

Meanwhile, emerging markets have been growing very quickly in the global recovery. When countries grow, they need to issue more currency or suffer deflation, because they would not have enough money chasing the expanding amount of goods and services. So, for emerging markets, economic growth means having their central banks issue more currency and then buy more US Treasury debt.

Despite this, there are those who will claim the US trade deficit is unsustainable because it requires us to sell more and more assets to foreigners, going deeper and deeper into “net debtor” status. What these analysts are missing is that despite owing foreigners a great deal more than they owe us – that’s why we’re called a “debtor” country – US investors consistently earn more on their foreign assets than foreigners earn on their US assets.

This is complicated so here’s a simple example. Let’s say George owes Ivan $100 and at the same time Ivan owes George $50. Obviously George is the net debtor, by $50. But let’s also say George has to pay an interest rate of 3% on his debt to Ivan, while Ivan pays an interest rate of 8% on his debt to George. Then, despite being the net debtor, every year George gives Ivan $3 while Ivan pays George $4. Who would you rather be? George, obviously!

In the real world, the US is George. Although our investments abroad are smaller than foreigner investments here, US investments have earned $145 billion more than foreign investments in the past year. Free markets, property rights and enforceable contracts remain the true attractors of capital. As a result, capital will continue to flow to the US because it is viewed as a refuge from risk, even when returns appear low. Remember, there are always two sides to a coin. And looking at the other side gives a significantly different view.
Pretty cool, huh?  Now, Morici and others want us to be Ivan.  I'd prefer that we remain George (crazy, I know).

Which guy do you want us to be?

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