August 13, 2004
Soaring imports of oil and Chinese goods drive trade deficit to new record
The U.S. Department of Commerce today reported that the merchandise trade deficit reached a record level of $631 billion at an annual rate in the first half of 2004, an increase of 15.3% over the same period in 2003 . The aggregate U.S. trade deficit, which includes both goods and services, was $575.5 billion at an annual rate, a 15.7% increase. Growth in the deficit reflects surging imports and continuing, rapid decline in the competitiveness of U.S. manufacturing industries. The merchandise deficit as a share of U.S. gross domestic product (GDP) increased to an unprecedented 5.3% in the second quarter of 2004.
Dramatic increases in the cost of petroleum products and the volume of imports were responsible for more than one-third of the increase in the trade deficit in the first six months of 2004. The average unit value of all energy-related petroleum products increased 14.8% over the same period in 2003. In addition, import volumes increased 6.5% in the first half of 2004 compared to the first half of 2003. The fact that consumption of petroleum imports continues to grow despite rapidly rising petroleum prices illustrates the insensitivity of energy demand to significant price increases.
The 9.7% annual decline in the real value of the U.S. dollar since the first quarter of 2002 has yet to start the process of reducing the trade deficit. As the dollar declines, it makes U.S. exports cheaper in many foreign markets and makes our imports more expensive. The dollar fell much more against the Euro (38% in nominal terms), than other currencies. Asian nations, in particular, engaged in heavy intervention in foreign exchange markets in order to prevent the dollar from falling against their currencies (see updated snapshot for March 22, Foreign government intervention keeps the value of the dollar artificially high).
China’s trade surplus with the United States increased 27.1% in the first half of 2004, to $68.5 billion. China has refused to increase the value of its currency, which has expanded the trade gap. China’s intransigence has also made it more difficult for other Asian nations to allow their currencies to rise. The U.S. trade deficit with China is now the largest with any country in the world. China alone was responsible for 53% of the increase in the non-oil trade deficit through June 2004. U.S. imports from China are now five times the value of our exports to China, making this the United States’ most imbalanced trading relationship.
The U.S. trade deficit poses great risks for the economy. The U.S. must borrow abroad to finance its trade deficits. The recent decline in the dollar indicates that private foreign lenders are less willing to supply new credit. Foreign governments have been forced to step into the gap and finance a growing share of U.S. international debt. A rapid, uncontrolled decline in the dollar could push the U.S. economy into a sharp recession. (See the June 30 Snapshot, Rapid increase in foreign liabilities threatens U.S. recovery). Foreign governments provided 86% of total capital inflows in the first quarter of 2004, and 94% of these inflows were from Asian governments.
The U.S. trade deficit with the Pacific Rim has increased 17% thus far in 2004, reflecting deep changes in the structure of trade with Asia. The U.S. deficit with Japan increased 12.5%, after declining for several years. In addition, Japan ‘s global trade (current account) surplus is also growing rapidly. Japan and other newly industrializing countries in Asia are expanding trade with low-wage assemblers in China, Mexico, and elsewhere in Latin America to target open U.S. markets through many marketing channels.
The U.S. deficit with Western Europe rose 16.9%. This is particularly surprising due to the sharp appreciation of the Euro since 2002. This rising deficit with Western Europe reflects the strong export performance of the European producers, despite substantial increases in the Euro. Nonetheless, the deficit with Europe should begin to fall at some point in the next year or so as the effects of the lower dollar kick in. The small U.S. deficit with South and Central American economies continued to rise sharply in the first half of 2004, reflecting the lingering effects of the financial crises of the late 1990s and the globalization of export supply chains.
The gain in the real value of the dollar between 1995 and 2002 helps explain the rapid growth of the U.S. trade deficit results. The dollar began to rise significantly in 1997 and peaked in 2002, as shown in the figure above. It usually takes 12 to 18 months for the nominal trade balance to respond to a change in the value of the currency. However, the U.S. trade deficit has continued to rise in real terms, and as a share of GDP, through the ninth quarter after the dollar peaked in February 2002. During the trade and dollar crises of the 1980s, the dollar fell much more rapidly (17.7% within six quarters) than it has since 2002 (a decline of only 9.7%). The dollar must fall much more to achieve a sustainable level of the trade deficit.
A 30% fall in the dollar from 1985 to 1988 was required to reduce the real trade deficit from about 3% of GDP to 1% of GDP by 1989. The dollar stayed down in that range through 1997 and the deficit stayed around 1% of GDP (except when the recession of 1990-91 pulled the deficit down to zero). Bringing down the 2004 deficit of 5.3% of GDP will require a much larger devaluation of the dollar. U.S. imports are now 51% larger than U.S. exports. Closing this gap will require a huge increase in domestic production of manufactured goods. Domestic output is now just 76.5% of domestic demand for manufacturers, substantially less than the 1987-1997 average of 90%. Domestic manufacturing output would have to increase by nearly 18% in order to raise output to its previous share of demand and produce enough domestically made goods to shrink the trade deficit.
Manufacturing lost 3.3 million manufacturing jobs between December 1997 and December 2003. Although 91,000 jobs have been added in the manufacturing sector since January 2004, the manufacturing trade deficit has continued to expand. The U.S. deficit in the first half in manufactured goods rose from $216 billion in 2003 to $252 in 2004 alone, an increase of 16%. Strong growth in domestic demand has been required to offset this continuing decline in international manufacturing competitiveness.
—by Robert E. Scott
Thanks to David Ratner for Research Assistance.
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