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JULY 26, 2004
U.S.: The Trade Deficit May Soon Cause Less Pain A weaker dollar and stronger global demand will slow down the beast The trade deficit has been a thorn in the side of the U.S. economy for the past seven years. Over that time, the ever-widening gap subtracted, on average, 0.7 percentage points per year from overall economic growth. Except for the larger deficit, the economy would have grown 3.8% annually instead of 3.1%. The import side of the ledger has accounted for much of the widening. The U.S. led the global upturn, with help from China, resulting in sharply faster growth in U.S. demand for imports, while U.S. exports were stuck awaiting better demand from overseas and a more competitive dollar. The trade gap's drag on U.S. growth will likely continue, but the May data offer some hope that the rate of deterioration is easing. World growth is accelerating, so U.S. exports are picking up speed. Yet at the same time, domestic demand is coming off the boil, after being heated up by steep tax cuts and super-low interest rates. As a result, import growth is bound to slow somewhat. Still, any improvement in the trade balance this coming year will be painfully slow. One reason is currency patterns around the globe. True, the dollar has fallen 22% from its peak in early 2002, as measured against several major currencies. That is lifting export competitiveness and the prices of many imports. But it's not the major economies that are causing the deficit to balloon. The U.S. trade gap with the other members of the Group of Seven has accounted for only 12% of the total deficit's deterioration in the past three years. The bulk of the widening has come from trade with developing nations. For example, America's growing trade gap with China, India, and Asia's Newly Industrialized Countries (NICs) of Hong Kong, Singapore, Taiwan, and South Korea contributed 38% of the overall gap's three-year deterioration. But China fixes its currency to the dollar's level, and other Asian countries actively manage their exchange rates. That's why the dollar is down only 11% vs. a broader set of currencies, exerting less upward push on import prices. Slow progress on the deficit means political pressure over trade issues, especially job outsourcing, is sure to intensify as the November elections near. Already, the phrase "fair trade," typically associated with protectionist remedies, is showing up in campaign speeches. DESPITE SUCH RHETORIC, there are reasons for optimism in the trade outlook, especially for exports. Indeed, a rebound is already under way. Total exports jumped 2.9% from April to May. That helped to narrow the trade deficit to $46 billion, from April's record $48.1 billion. Goods exports alone were up 18.8% from a year ago. That's the fastest annual clip in more than nine years, and it's a stark turnaround from two years ago, when merchandise exports were falling 8.8%. The rebound has been widespread so far in 2004, vs. last year's first five months. For instance, of the 47 items listed under industrial materials and supplies, only three are running below 2003 levels. Others, like organic chemicals, plastic materials, and precious metals, are growing at double-digit rates. 
For capital equipment, by far the largest category of U.S. exports, the gains are equally impressive. Total capital goods shipments so far in 2004 are up 16.3%, with high-tech exports up 15%.Global demand for business equipment should stay strong next year since companies in major industrialized nations are trying to mimic their U.S. rivals and boost productivity, while newly emerging economies are expanding their facilities or establishing new industries. The Institute for Supply Management reported that export orders continued to grow in June, with electronic components and equipment leading the way. SO WHO'S BUYING U.S. EXPORTS? Not surprisingly, the two leaders remain America's neighbors, Canada and Mexico, who together purchased $122 billion in goods so far this year, a 10.9% increase from 2003. The European Union's demand for U.S. merchandise is up 12.1%, while slowly recovering Japan's purchases have risen 3.6%. But it's the developing economies where demand for American goods is exploding. The U.S. has increased its exports to the four Asian NICs by 22.3% so far this year. Sales to China have mushroomed 37.2%, and shipments to Eastern Europe are up 41.6%. While this year's export surge means that year-over-year comparisons may start to soften, the outlook for global growth is solid enough that U.S. exports should continue to climb. The Bank of Japan has upped its forecast for Japanese growth into 2005. And the International Monetary Fund expects the world economy to remain very healthy. Growth in emerging markets should hit 5.9% next year, little changed from this year's 6% forecast. And the euro zone and Canada's growth rates are expected to accelerate. Meanwhile, China's efforts to rein in the expansion of its factory sector is not a worry. China will still need to purchase the kinds of capital goods that the U.S. excels at exporting. THE IMPORT SIDE of the trade deficit will remain a tough problem, although perhaps not as intractable as in recent years. That's because U.S. demand shows signs of cooling from its superheated growth rate of the past year and a half to a more sustainable pace. U.S. imports rose a slim 0.4% in April and May. Compare that with monthly gains averaging 1.8% during the previous six months. Slower import growth coincides with the easing of overall consumer spending in the second quarter, perhaps to the slowest pace in more than a year. That was evident in the June data on retail sales, which fell 1.1% from May. Imports of consumer goods, not including autos, plunged 3% in May, the largest monthly decline in more than a year and a half.  But the trend of overall import growth is likely faster than the latest data suggest. The May weakness in imports of consumer goods reflected two large, quirky-looking drops that will not be repeated in June: One in artwork, the other in pharmaceuticals. Plus, imports of capital goods grew a slim 0.2% in May, even though businesses continue to ramp up outlays for equipment.As for the dollar, its decline will help to slow imports somewhat. Already, the dollar's drop against the euro and the yen has lifted the prices of goods from Europe and Japan. But the weaker greenback has done little to stem the tide of imports from Asia. Goods from China, for example, have soared, accounting for 21% of the growth in U.S. imports during the past year. At the same time, Asia's NICs have swallowed the currency shifts in order to guard market share. Prices of their imports are down 0.7% from a year ago. Nevertheless, as U.S. demand settles down to a more sustainable clip in the coming year, import growth also will slow. Even the rapid pace of imports from China will cool off a bit, whether Beijing revalues its currency upward or not. Add in the improving outlook for exports, and chances are very good that the trade deficit will at least stabilize in the coming year. It might even edge down a smidgen, adding to -- instead of cutting from -- U.S. economic growth.  By James C. Cooper & Kathleen Madigan
BW MALL
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