Trade Deficit Grows in January
The global recession and the strong dollar are causing the trade deficit to widen again, setting the U.S. economy on a course that may prove difficult to maintain.
The Commerce Department reported Tuesday that the trade gap expanded to $28.5 billion in January from $24.7 billion in December. Last week the government said a broader measure of the trade shortfall rose slightly in the fourth quarter of 2001.
The growing gap between exports and imports points to what some analysts consider the Achilles’ heel of the U.S. economy: its increasing dependence on foreign capital. Every dollar of trade deficit moves another dollar into foreign hands, and analysts warn that there is a limit to how many dollars foreigners are willing to hold.
“Basically, the United States is asking global investors to perpetually increase the share of U.S.-denominated securities in their portfolios,” said Goldman Sachs senior economist Jan Hatzius. “That at some point just will not be sustainable.”
The reason has to do with the unconventional behavior of the world economy and the American dollar.
The recession that appears to be ending in the United States was only part of an unusual, worldwide downturn. In a typical domestic recession, the trade deficit shrinks because exports hold their own even as American consumers buy fewer foreign goods.
Because this recession is global, however, U.S. exports have been hurt by weak foreign demand. That kept the trade deficit from narrowing much during the recession, and it is causing it to expand quickly as the economy speeds up.
Another anomaly is at work in this cycle. The dollar has continued to rise in value, despite downward pressure exerted by low U.S. interest rates. Normally, the dollar weakens as foreign investors seek higher returns elsewhere. Exports surge because dollars are cheap in foreign countries, and the trade balance improves. But for now the U.S. dollar is maintaining its high value--and U.S. products, their high price.
The unusual pairing of a muscular dollar and a puny world economy has pummeled U.S. manufacturers, which are bearing the brunt of an otherwise short and shallow recession.
No Mild Downturn for U.S. Manufacturers
“For manufacturing, this was anything but a mild downturn,” said Mark Zandi, chief economist at Economy.com in West Chester, Pa. “It was a full-blown, outright recession, even more severe than 1990-91.”
Some economists say the worsening trade balance will inevitably cause the dollar to depreciate, as foreigners become increasingly wary of the U.S. investment outlook and move their money elsewhere.
It’s an adjustment many consider overdue. But a sudden and sharp descent could be painful. Prices of imported goods would jump, reducing living standards and possibly rekindling inflation. Stock and bond prices could plummet, and interest rates would probably rise. If the jolt was severe enough, it could even trigger a recession.
Foreigners already hold 36% of all U.S. Treasury securities, 21% of all corporate bonds issued by U.S. companies and 11% of their publicly traded stock, according to Goldman Sachs.
America’s net foreign debt was $2.2 trillion at the end of 2000, equal to roughly 22% of the nation’s gross domestic product. If current trends continue, the firm expects foreign debt will reach $5.8trillion, or 50% of GDP, by 2006.
“There is a real risk that at some point, foreign exchange traders will find that the dollar isn’t particularly attractive,” Hatzius said. “I don’t think it’s going to lead to mayhem in the U.S. economy overall, but it could be quite a big event in the FX [foreign exchange] market.”
Although many economists expect the growing trade gap to force the dollar to lose value some day, they say the transition should be manageable as long as it proceeds in an orderly fashion.
“It certainly seems that investors around the globe are more than willing to hold the bucks that they’re accumulating because of this current account deficit,” said Stephen Slifer, chief U.S. economist at Lehman Bros. “They had ample opportunity to pull the plug already, and they didn’t.”
The current account includes investment flows as well as trade in goods and services, which is measured by the more familiar trade balance.
Good Can Come
From Large Deficit
A large deficit is not inherently bad. It means the United States is borrowing from foreigners to finance a portion of its domestic spending and investment. If the foreign money is used productively, as it was in the 19th century to build railroads, America comes out ahead.
A strong dollar can be a good thing, too. In recent years, it helped keep inflation at bay by reducing the price of imports, and attracted the foreign funds needed to finance the investment boom of the late 1990s. The result: low interest rates, high employment and, until last year, robust economic growth.
“The flip side of the very large deficit is the strong capital inflows into this country,” said Jay Bryson, global economist with Wachovia Securities in Charlotte, N.C. “One of the reasons foreigners are willing to invest in the U.S. is their belief that the dollar will continue to get stronger.”
But there are inevitable trade-offs. If the trade deficit gets out of hand, future living standards will be reduced as the nation devotes an increasing share of its economic output to foreign debt service.
In the meantime, the strong dollar will continue to clobber manufacturers, causing more business failures and work-force reductions. More than 1.7 million factory jobs have disappeared since mid-2000.
David Barge, president of family-owned Barge Forest Products Co. in Macon, Miss., is troubled by what he sees.
In a good year, about a third of the firm’s $11 million in revenue comes from sales of high-grade yellow pine to foreign furniture makers. Exports accounted for only about one-quarter of last year’s revenue, as the rising dollar increased the cost of Barge’s products in overseas markets.
Barge tried to hold on to the business by cutting prices, but some buyers had already left the fold.
“So much of it is psychological,” said Barge. “When our customers see the dollar at a certain level, they say they’re not going to buy any USA wood because the exchange rate is just too high. You can’t talk to them.”
Zandi, the Economy.com analyst, estimates that one in five factory jobs lost since mid-2000 was a casualty of the strong dollar. Even if the U.S. economy quickly recovers, the attrition among manufacturers whose products compete with foreign-made goods will continue as long as the dollar remains strong.
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