Our Trade Problem

Today’s trade release by the Commerce Department is interesting from a number of angles. Let’s get the hard data out of the way first: the US trade deficit widened in March, which is the month for which we have the latest information. The gap between exports and imports rose to $27.6 billion, up from $26.1 billion in February. The short term significance of this change is that the February number had been the smallest trade deficit for nine years and was the last of eight consecutive months during which the gap narrowed. The dramatic shrinkage in the trade gap since the middle of last year has been a fairly important factor in holding GDP higher than it would have been otherwise: net exports are counted as a component of GDP with exports adding and imports subtracting from the total. So the steady drop in imports implied that a higher percentage of our demand was being met from domestic production.

Or at least that’s the way it appears under normal circumstances.

In reality the drop had more to do with the collapse of world trade, the drop in US consumption, and the equally dramatic fall in world commodity prices. The fall in US domestic demand, which is the root problem we are trying to deal with, obviously resulted in less demand for imported goods. At the same time the worldwide recession caused prices of things such as oil to fall from their peaks and so imports cost less. So not only were we importing fewer things, they were costing less as well. That should have been a boost to our well being except that a large part of the gain was offset by the loss of export markets as foreign consumers cut back on their purchases of American made goods and services.

So not only was the gain in net trade smaller than it might have been, it was somewhat of an illusion. I have no doubt that once our economy regains momentum the trade deficit will start to widen again.

And therein lies the rub.

As we re-engineer our economy so it relies less on debt fueled consumption, which will be one of greatest challenges over the next decade, we will be faced with a conundrum: what will replace consumption as the engine of the economy?

I am not suggesting that consumption will ever be replaced as the major driver of growth. My point is that as we shift away from debt towards a more balanced approach to spending, and as savings chew up a larger portion of incomes, consumption will have to back away from being closer to 70% of GDP which is what is has been recently. I expect it will settle somewhere lower and contribute between 60% and 65% of GDP each year. That decline from 70% to 60% will need filling if we are to see GDP grow.

And that’s the dilemma policy makers must face.

Where will that needed addition to the economy come from?

Countries that have previously experienced the kind of severe downturns we going through have typically turned to trade as a primary source of that addition. Japan, whose experience in the late 1990’s we have all talked about so much recently, was able to mitigate its drop in domestic demand by boosting its exports with its Asian trade partners in particular. The boom in China nicely coincided with Japan’s need to find a way to support itself and so exports to China helped mask Japan’s population from their dramatic drop in consumption. Without the trade boom Japan saw at that time its economic woes would have been far more severe and had much more impact on its consumers.

I doubt we will be so lucky.

The recession is worldwide. America plunged down first, so it is likely it will re-emerge first also. That means most, if not all, our trade partners will be still battling the downturn just as we are looking for trade opportunities.

So just when we need trade the most to help offset our own lost demand, and to assist us restructure our economy, the chance of opening up trade will be severely limited.

This is why I think growth is likely to be well below historical averages for quite some time, even after the recovery is well established. In fact I think the adjustment period of slow growth could easily be as long as five years.

People who expect us to rebound back to a typical growth rate either underestimate the difficulty represented by this trade dilemma, or are expecting Americans to go back to their bad debt habits.

My own view is that ‘de-leveraging’ – the cutting back on debt – by both households and businesses will be a dominant theme for years to come. In fact I think the government too will be engaged in debt reduction.

Eventually the Chinese and other emerging markets represent our best hope of re-establishing a more healthy and balanced economy here in the US. Their drive towards higher living standards offers us the chance to export and meet some of their demand. But until those economies get back on track ours will be held back as well.

So trade is another cause of caution concerning the future.

Those trade gains we have seen since the middle of last year need to be made permanent.

Only this time for the right reasons.