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Business Outlook: U.S. Economy
U.S.: The World's Pain Is America's Gain
Low-priced imports and a glut of capacity will keep inflation low
The pairing couldn't have been more apropos. The simultaneous release on Mar. 18 of government data on the trade deficit and consumer prices highlighted the relationship between weak global economic conditions outside the U.S. and the stellar performance of U.S. inflation. Moreover, the trade gap's latest dramatic widening suggests that global forces will continue to restrain inflation for the rest of the year.
In recent years, the widening trade deficit has been the U.S. economy's safety valve. It has helped vent price pressures by giving consumers and business access to cheap imports, while weak export markets have kept production capacity from becoming overextended.
None of this seems likely to change anytime soon. The U.S. trade deficit, which appeared to have bottomed out toward the end of last year, widened with a vengeance in January, as a new round of export weakness met with renewed growth in imports.
And on the inflation front, the February consumer price index rose a mere 0.1% for the third month in a row. Annual inflation has held steady at between 1.5% and 1.7% for more than a year, and in February, annual core inflation dipped to 2.1%, the lowest since 1966. The recent jump in oil prices will lift overall inflation this year, but the core rate should stay low.
THE BAD NEWS is that the wider trade gap will be a huge drag on first-quarter economic growth. The gap for goods and services increased to $17 billion at the start of 1999, a leap from an average of $14.4 billion per month in the fourth quarter, when the deficit actually improved from the record $15.5 billion average in the third quarter.
Trade subtracted perhaps as much as two percentage points from overall growth in gross domestic product. First-quarter domestic demand appears to be growing at a strong 4%-to-5% pace. Consumer spending and housing are leading the way, but weakness in durable goods orders and shipments in February suggest that capital spending is slowing.
The growing deficit is sure to provide new fodder for the protectionists in Washington, especially since nonoil imported goods now account for more than 30% of U.S. demand for such goods. On Mar. 17, the House of Representatives voted 2 to 1 to slap quotas on foreign-made steel, even if a country is not violating anti-dumping laws. The bill, which defies World Trade Organization and NAFTA tenets, is unlikely to pass the Senate, but it has raised international concern from Canada to Brazil. And in addition to the banana flap with Europe, the U.S. is now threatening new trade barriers on some $900 billion in European goods over Europe's refusal to buy U.S. hormone-treated beef.
All this is a reminder that, in the long run, the U.S. cannot pile up international IOUs forever. At some point, probably when economic prospects outside the U.S. begin to improve, foreign assets will gain some allure relative to U.S. assets, and the dollar will begin to lose its muscle of recent years. A weaker dollar would slow imports in two ways, by making them costlier to U.S. buyers and by taking some steam out of the stock and bond market gains that have fueled domestic demand. However, that seems unlikely to happen in 1999, and in the meantime, look for the trade deficit to keep widening.
THAT'S BECAUSE EXPORT WEAKNESS has reasserted itself. Exports fell 1.4% in January, the third drop in a row after strong gains in September and October. Part of the renewed decline reflects spreading malaise in Latin America and slower growth in Europe, even as Asia appears to be stabilizing. In particular, exports to Latin America are down 2% from a year ago, when they were growing in excess of 20% (chart).
However, part of the export reversal reflects the end of the strike at General Motors Corp., which boosted cross-border exports to Canada and Mexico last fall. Also, part of the latest weakness reflects a well-established quirk in the Commerce Dept.'s seasonal adjustment of the data, which tends to lessen the deficit in the fourth quarter only to enlarge it in the first. Commerce thought it had solved the problem, but the sharp January swing in the data suggests not.
Meanwhile, import growth will not let up, and it may even speed up. Despite accelerating growth in U.S. domestic demand last year, import growth actually slowed a bit. But in January, imports jumped 2%, suggesting that this paradox in last year's data may be working itself out in favor of stronger import growth.
THE UPSIDE TO MORE IMPORTS is the restraint that they put on overall U.S. inflation. Producers are benefiting the most. With global demand so weak, commodities such as steel, foodstuffs, energy, and chemicals are cheaper than they were a year ago. In fact, commodity prices stand at a 12-year low.
Consumers are also profiting, but to a lesser extent, because more than half of the average household budget is spent on services, which can't be substituted with a cheaper import. The payoff for consumers comes mostly on the goods side. Indeed, the lowest inflation or outright deflation is evident mostly in markets that face serious import penetration. For example, apparel prices are down 1.7% from a year ago, and a bottle of wine costs just 1.6% more.
In addition, oil has been a big reason for the current low rate of inflation. Low foreign demand had pulled down crude prices to a 12-year low of $11 per barrel in late January. But then members of OPEC began to talk about setting lower production quotas--and abiding by them. In response, oil prices shot up to over $15 a barrel (chart), and gasoline prices rose by 9 cents.
On Mar. 23, OPEC members and four non-OPEC countries agreed to cut crude-oil production by 2.1 million barrels a day for a year beginning Apr. 1. If the plan sticks, and there is plenty of doubt that it will, gas prices would rise even further. Adjusted for inflation, of course, gasoline is cheaper now than it was before the first oil crisis of the 1970s. However, the recent increase in fuel prices will lift total inflation in coming months.
For goods and services insulated from foreign trends, inflation is more apparent. Prescription drugs are up 5.4% from a year ago, while health-care services are 3.4% more costly. Cable-TV fees are up 4.9%, and college tuition is up 4%. The impact of imports is why prices of core goods are up just 0.7%, but core service prices are rising 2.8%.
This dichotomy between goods and services is unlikely to end soon. Producers everywhere have no place to sell their products except in the U.S., and the rising dollar means that they can cut their prices to gain market share. Simply put, the world's pain is the U.S.'s gain. And until foreign economies recover and their own domestic demand picks up, the U.S. will enjoy a very sanguine inflation outlook.BY JAMES C. COOPER & KATHLEEN MADIGANReturn to top