Stall in the Trade Deficit Decline Spells Woes for U.S.

The outsized U.S. trade deficit, which declined smartly last year, is leveling off at an ominously high plateau.

Even the most optimistic forecasts show it shrinking only marginally for the rest of this year, and some studies predict that it will soon start heading back up.

“Some very disturbing trends already are in place,” said William Cline of the Institute for International Economics.

The causes are wide ranging: from the stubbornly strong dollar to the low U.S. saving rate, from American consumers’ insatiable appetite for imports to American manufacturers’ traditional reluctance to export.

And the possible consequences are alarming: upward pressure on prices, new turmoil in financial markets and, ultimately, the end of the U.S. economic expansion, which is now in its seventh year.

But the prescriptions for reducing the trade deficit further are not particularly appetizing either. The United States could push the dollar’s value down further, which would increase the attractiveness abroad of U.S. products but would aggravate inflation. Or it could intentionally slow the economy enough to curb the appetite for imports.

“The trade-offs now are all bad,” said David D. Hale, chief economist of Kemper Financial Services in Chicago. “Anything that policy- makers do to deal with the problem is likely to be painful.”

Four years ago, by contrast, the cure for the growing trade deficit seemed clear--a cheaper dollar. The highly valued dollar had made imports cheap in the United States and U.S. goods expensive abroad.

The dollar began declining in 1985 and, after a longer-than-expected lag, the trade deficit finally shrank markedly in 1988 to $120 billion, down more than 20% from the record $152 billion the year before. It was the smallest annual trade deficit since 1984.

Already, however, improvements in the trade deficit have stopped, and the monthly merchandise trade deficit has been stuck on a plateau for about six months. The Commerce Department reported recently that the trade deficit for February widened to $10.5 billion, up from $8.7 billion the previous month.

Dollar Relatively Stable

At the rate of the first two months of the year, the 1989 trade deficit will reach about $114 billion, only a slight improvement from 1988.

The stall-out can be traced to a host of factors:

Although the dollar’s value has declined dramatically from its peak in early 1985, it has remained relatively stable for the past 20 months. Thus, U.S. goods have gained no price advantage for that long in their competition with foreign products.

Despite some recent signs of a slowdown in the economy, Americans are still consuming far more than they produce and relying on imports to make up the difference.

Many popular consumer items, such as videocassette recorders, are not made in the United States. Likewise, many of the capital goods that industry needs for expansion--essential items such as machine tools and electronic equipment--can only be purchased abroad.

Many U.S. industries--such as chemical producers and pulp and paper manufacturers--are operating at flank speed and cannot move to boost production quickly enough to take advantage of export markets. Many U.S. firms have been reluctant to spend money to increase their production capacity until they become convinced that the overseas market will last.

Oil prices are rising again, increasing the dollar value of the goods that the United States imports. Although the value of oil imports fell $3.4 billion in 1988, it is expected to rise $10 billion this year and another $8 billion in 1990.

Finally, Americans are not saving enough to finance what the country needs to invest in new production facilities. As a result, America--both the government and individuals as well--must borrow the difference. And to be able to cash in their foreign money, they must use it to buy goods and services from abroad.

Any serious move to help bring the trade deficit down further is likely to spawn problems of its own.

Fed May Push Rates Up

Robert Z. Lawrence, an economist at the Brookings Institution in Washington, warns that pushing the dollar’s value down much further would add to inflation by raising import prices significantly. And a cheaper dollar, he says, would make it even easier for foreign investors to buy U.S. firms and real estate at bargain prices.

At the same time, Lawrence points out, a cheaper dollar would discourage foreign investments in U.S. stocks and bonds because their rates of return would decline with the dollar. That would deprive the U.S. economy of an important source of funds.

To prevent the dollar from plummeting, the Federal Reserve might feel obliged to push interest rates up, even though that would slow the U.S. economy.

Another possible solution is to reduce the federal budget deficit. That would free up more domestic savings for more productive investments than Treasury securities and at the same time it would curb Americans’ appetite for imports by having a depressing effect on the economy.

But if imports fell too sharply, that could seriously hurt the economies of such U.S. allies as Taiwan and South Korea, which depend heavily on sales to the United States. That is why economists prefer to narrow the trade gap by raising exports rather than lowering imports.

“We’ve essentially run out of options,” Barry P. Bosworth, a Brookings Institution economist, said.

Not all analysts find the long-term outlook so bleak.

“While it is admittedly true that there has been a certain marking of time in the rate at which these external imbalances are being reduced, the basic trend remains one of encouraging improvement,” said Satoshi Sumita, the governor of the Bank of Japan.

Paul R. Krugman, a Massachusetts Institute of Technology economist, believes that it is too early to tell whether the improvement in the trade deficit has stalled. He points out that the combination of the lower dollar and stable wages have made the United States an inexpensive place in which to produce, compared with most other industrial countries.

‘Reindustrialization’

“No matter what the econometric models say, it’s hard to see why, given a little time, U.S. firms shouldn’t shift their production facilities back to the United States,” he said. “If they do that soon, over the long haul, you’d find that our exports would increase.”

Krugman already sees some evidence that the impact of the weaker dollar is slowly bringing about “a fundamental reindustrialization” in this country that eventually will see American firms moving back into industries they once abandoned.

“The problem is, the things you could do quickly in that line are pretty well exhausted,” Krugman said. “You have to allow a five-year time horizon for any change. The dollar must stay where it is during that period, and people must be confident that it’s going to stay.”

But many economists find little room for hope. Hale says the stall-out seems almost certain to push the dollar lower as currency investors lose confidence in the future of the U.S. economy. To prop up the dollar, he says, the Fed will raise interest rates here at home.

That, he predicts, will “almost guarantee stagflation”--the kind of slow growth and high inflation that characterized the 1970s. “There’s no question,” he says, “that the stall-out is here.”