The Reality of Trade Deficits

The trade deficit jumped this month by almost 10%, to $63 billion. To hear the candidates talk, we can lower the deficit by forcing China to allow its currency to rise, increase our exports because of a lower dollar, stop our dependence on high-priced foreign oil, etc. Whatever the problems are, they are not of our making.

Let's look at the reality. I asked my friends at Plexus to create a few charts for me. First, let's see if a lower dollar will have a major impact on the deficit. The deficit is in red, and the numbers for the dollar index are on the right. Notice that from 1992 until 2002 the dollar got stronger and the trade deficit rose. Of course, there was the period from the end of '93 until '95 where the dollar dropped almost 20% and had seemingly very little effect on the trade deficit.

Now notice that from 2002 until the present the dollar has gone down and the trade deficit has exploded. If a weaker dollar were the answer, then one would expect the trade deficit to improve. Yet, the deficit has roughly doubled since 2002 while the dollar has dropped by more than a third. Using a trade-weighted dollar index would produce the same visual results, although the trade-weighted dollar has dropped by "only" 25%.

As I have maintained for years, I expect the Chinese to allow their currency to rise slowly. By the time the next president can have a foreign policy team in place to focus on the issue, the Chinese will have allowed the yuan to rise another 15% or so. This will bring it very close to the 30% increase in valuation that the China hawks in Congress have been wanting. The reality will be that the Chinese will have done almost all the heavy lifting within 18 months.

What will be the result? It means that the $325 billion in goods and services that we buy from China will cost us 10-15% more than it does now. Will we buy 15% less? Not if that is how we want to spend our money. And that brings us to the next chart. While there is not an exact correlation, the trade deficit rises as consumer spending rises, which makes sense if you think about it.

Want to see the real problem at the root cause of the trade deficit? The one that candidates absolutely cannot mention from the debate podiums? Look at the next chart:

No, the simple answer is that the trade deficit is not going to come down until the US starts to save more and spend less. In 1992, consumer spending was a little over 65% of GDP. It is now closer to 72%. Savings are down from 8% in that time, to barely above zero. If US consumers simply saved 5%, as we did 10 years ago, the trade deficit would come down by a lot.

But it would not go away, because we, like all developed countries, are addicted to energy consumption, and for now that means oil. We imported $34 billion in petroleum products in November, a jump of 10% over the next highest month on record. (By the way, you can get 47 pages of small-print numbers on all aspects of trade at the main web site at the US Census Bureau at http://www.census.gov/foreign-trade/Press-Release/current_press_release/press.html. The data I cite is from there.)

In large part, that is because of soaring oil prices. But it may get worse. We actually imported less oil in November in terms of barrels of oil than the average for the last year, but the price was up from an average of $72 in October to almost $80 in November. Oil at $95 has not yet made it into the actual price. Another $15 a barrel could add as much as $50 billion to the annual trade deficit.

That means oil alone will soon be more than 60% of our trade deficit, if oil stays above $90 a barrel. Hard to cut the deficit with a lower dollar if we keep buying expensive oil.

Some random items from pages 21-22 of the report. We imported $193 billion in autos for the first 11 months of the year. $618 million in sugar. $118 billion in TV's, VCR's and other electronic gadgets. We imported $219 billion just in crude oil.

Quick: who's our biggest trading partner? Canada, by a wide margin. We import almost the same from Canada as we do from China ($289 billion to $295 billion), but we also send them $229 billion. Yes, we ran a trade deficit with Canada of $59 billion for the first 11 months of the year. ($67 billion with Mexico.) The rapidly rising Canadian dollar has barely made a dent in the deficit. Yet Senators Schumer and Graham (bipartisan economic illiterates) think a rising Chinese currency will lower the trade deficit with China when it has done no such thing with Canada, and dropped the $112 billion deficit with Europe by just 10%, almost entirely composed of lower imports and only a little by increased exports.

And yes, our deficit with China is going to be in the $260 billion (annualized) range. Dropping that by 10% would not change the deficit that much. You reduce the trade deficit by spending less and exporting more.

However, we would have to grow exports by 90% to balance the trade deficit. Exports are up by 12% over a year ago, and most categories are up, but it is simply not realistic to think we can grow our way out of the trade deficit.

The heavy lifting on reducing the deficit is going to be by a reduction in spending. And that is only going to happen when people realize they have not saved enough for retirement and their homes are not a piggy bank that can be cashed out for retirement. And reduced consumer spending will not happen on just imports. It will be across the board and a drag on the economy. Wishing for a lower trade deficit may bring along problems that are not mentioned in the debates.

Yes, if we can develop coal-to-natural-gas technologies (there is considerable hope on that front), bio-fuels (not ethanol, which is a really bad idea, unless you grow corn) and a conversion to electric-based cars, the developed world can rid itself of oil addiction. But that is going to be at least 10 years down the road, if not a lot longer.

So, the next time some candidate says we have to lower the trade deficit, ask him how he plans to do that. Exactly what policy is going to make a difference, unless we erect trade barriers? See if the candidate says we need to spend less.