Bear in mind that these global imbalances didn't happen overnight. In 1992, the U.S. trade deficit for goods and services totaled $39.1 billion for the whole year. For December, 2004 alone, the gap was $56.4 billion. After adjusting for prices, the growing trade gap subtracted six-tenths of a percentage point from economic growth last year. The current account, the sum of all foreign transactions including income on assets, was roughly in balance in 1992. In 2004, the current account deficit was equal to about 5.5% of gross domestic product. It will probably go above 6% in 2005.
The magnitude of these numbers argues that any progress will be slow in coming. And unless the trade deficit is contained, at least as a share of GDP, the growing imbalance will further increase the risks of a run on the dollar that could generate severe ripple effects throughout the global financial markets.FEDERAL RESERVE CHAIRMAN Alan Greenspan touched on this and other subjects when he gave his semiannual testimony on monetary policy to Congress on Feb. 16. The Fed chief sounded hopeful that the dollar's decline since early 2002 would soon foster the price effects that will limit foreign imports and boost U.S. exports.
Earlier, in a Feb. 4 speech devoted solely to trade, the Fed chief ran through the reasons for the widening deficit. First, due partly to the dollar's previous strength, the level of imports is about 50% higher than exports. So, he noted, "exports must grow half again as quickly as imports just to keep the trade deficit from widening -- a benchmark that has yet to be met." Indeed, the latest trade data show that over the year ended in December, U.S. exports rose 11.2% while imports grew 16.8%. Yearly export gains have consistently lagged behind import growth during this business cycle.
The three-year fall in the dollar is expected to quicken the pace of exports this year. But the shortfall between export and import growth probably won't narrow much because of another reason cited by Greenspan: "The growth of the U.S. economy has exceeded that of our trading partners." And overall economic growth is a big determinant of a country's appetite for imports. But for instance, in the fourth quarter, the U.S. grew at a 3.1% annual rate, while Japan, Germany, and Italy all recently reported their economies shrank.For 2005, the U.S. seems poised to outpace the global economy once again. In conjunction with Greenspan's congressional testimony, the Fed released its central tendency forecasts for economic growth and inflation. Policymakers expect U.S. real GDP to grow 3.75% to 4% in 2005. By comparison, private economists see world growth at just over 3%.AND EVEN IF, BY SOME CHANCE, the global economy were to match the growth of the U.S. economy, it would not narrow the trade deficit. As Greenspan said: "The responsiveness of U.S. imports to U.S. income exceeds the responsiveness of U.S. exports to foreign income."
That differential is not new. This economic behavior, known as the Houthakker-Magee income effect, was first noticed back in the 1960s. However, the U.S. propensity to buy imports has been growing over time. According to economists at Soci?t? G?n?rale (SCGLY
), for each extra dollar spent today on consumer goods, excluding autos, 45 cents goes to imports. That share is up from 25 cents in 1997 and just 15 cents in 1990. The problem, as Greenspan said, is that even if the U.S. and foreign economies grow at about the same rate, U.S. imports will still grow faster than American exports will.
You would think the dollar's slide would curb Americans' appetites for imports. But that has not been the case so far. Although the dollar has plunged 15.4% in the past three years, nonoil import prices have increased only 6%. Greenspan noted that foreign producers are willing to swallow most of the cost of a cheaper dollar rather than accept a drop in their U.S. sales.AFTER ALL, the world's trade deficits and surpluses must all add up to zero. So if the U.S. reduces its gap, other countries must experience a shrinkage in their trade surpluses or a rise in their deficits. As Catherine L. Mann, a senior fellow at the Institute for International Economics, points out, foreign countries depend on U.S. imports both directly and indirectly for economic growth. This dependency is most apparent in Asia, but it is a trend around the world. And it argues that a shrinking dollar alone is inadequate to narrow the deficit.
In a speech last year, Mann laid out the mutual benefits and risks in what she calls "the global co-dependency" of the U.S. trade deficit. Overall, "countries have a vested interest in a large and chronic U.S. trade deficit. Their dependency on U.S. demand as a source of growth matches the U.S. dependency on foreign savings to finance domestic investment."
The Treasury's December report on international capital flows shows the U.S. continuing to benefit greatly from foreign savings. Foreign purchases of long-term securities ended 2004 on a strong note, with foreign buying averaging some $790 billion, at an annual rate. That's about $100 billion greater than the funds needed to finance the quarter's current account deficit. Asian policymakers especially are amassing U.S. government securities and working to stop the dollar's depreciation against their respective currencies in order to keep their products competitively priced for the U.S. consumer.
The risk is that the dollar will continue to slide, causing foreign-held U.S. assets to lose value. Says Mann: "These policymakers are trading off the positive certain benefits of export-led growth today against the negative certain capital loss on their holdings of U.S. assets tomorrow."For the U.S., Mann says co-dependency has the benefit of providing relatively cheap financing and expanding buying power that creates more demand for imports. At the same time, as foreign governments defend their currencies, the actions have limited the dollar's depreciation and hampered U.S. export growth. Little wonder the trade gap keeps rising.
Clearly, a combination of solutions will be needed to narrow the deficit. Further dollar depreciation will help, especially vs. the Chinese yuan. And the U.S. needs to increase its domestic savings. But whatever the mix of remedies, the trade gap has taken center stage, and don't expect it to go back into the shadows anytime soon. By James C. Cooper & Kathleen Madigan