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Trade Picture: February 10, 2005

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February 10, 2005

Soaring high-tech and other imports from China, sharply higher oil prices drive trade deficit to new record

The U.S. Department of Commerce today reported that the merchandise trade deficit reached a record level of $666.2 billion in the 2004, a 21.7% increase since 2003.The aggregate U.S. trade deficit, which includes both goods and services, was $617.7 billion, a 24% increase over 2003. The real goods and services deficit as a share of U.S. gross domestic product (GDP) increased to an unprecedented 5.8%in the fourth quarter of 2004. Growth in the deficit reflects surging imports and a continued, rapid decline in the competitiveness of U.S. manufacturing industries. The U.S. had a $37 billion trade deficit in advanced technology products (ATPs) in 2004, an increase of 38% since 2003.

Imports of high-tech goods from China were responsible for $36 billion of the $37 billion U.S. deficit in ATPs in 2004 (see EPI Working Paper #270). The growth of the ATP deficit was responsible for 13.5% of the increase in the non-petroleum goods trade deficit. While advanced technology goods were responsible for 19% of the growth in imports, they generated 24% of the growth in non-petroleum exports in 2004, which demonstrates that this sector has significant potential for growth in the future.

Total U.S. imports last year were $1.764 trillion, 54% more than the $1.146 trillion in exports. To keep the trade deficit from widening, the growth rate of exports must exceed the growth rate of imports by 54%. Last year, import growth (16.3%) exceeded export growth (12.3%), and imports expanded by $247 billion, almost twice as much as the increase in exports of $126 billion. If imports continue to grow at a 16% rate, the trade deficit will decline only if exports grow faster than 24.6%. In the absence of a dramatic and sustained slowdown in U.S. growth, exports can grow more than half again as fast as imports only with a substantial reduction in the U.S. dollar.

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 2004. The average unit value of crude oil imports increased 28% over 2003. In addition, import volumes also increased 4% in 2004. The fact that consumption of petroleum imports continues to grow despite rapidly rising petroleum prices illustrates the insensitivity of demand for oil imports to significant price increases.

The 14.1% annual decline in the real value of the U.S. dollar since the first quarter of 2002 has yet to reduce the trade deficit. As the dollar declines, it makes U.S. exports cheaper in many foreign markets and makes imports to the United States more expensive. The dollar fell much more against the Euro (54% in nominal terms) than against 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 the EPI Snapshot Foreign government intervention keeps the value of the dollar artificially high). Despite the decline in the dollar, non-petroleum import prices have only increased 5.9% since February 2002, which has blunted the effects of a weaker dollar on imports. This increase is smaller than the overall domestic price inflation, which has increased 7.0% since February 2002. Thus, imports became even more competitive than domestic goods in this period, despite the fall in the dollar. While there are signs that European exporters are beginning to increase prices, pressures to compete with Asian exporters with little or no exchange rate pressures are also restraining import price increases in many areas.

U.S. real trade deficit and the dollar, 1980-2004

China’s trade surplus with the United States was $162 billion in 2004, a 30.6% increase since 2003 and the United States’ largest bilateral deficit. China has refused to increase the value of its currency, which has expanded the bilateral trade gap. China’s intransigence has encouraged other Asian nations to slow or even prevent increases in their currencies. The U.S. trade deficit with China is now the largest the United States has with any country in the world. China alone was responsible for more than half of the increase in the non-oil trade deficit in 2004. U.S. imports from China are more than five times the value of U.S. exports to China, making this the United States’ most imbalanced trading relationship. The U.S. imports from China were $196.7 billion in 2004 (an increase of 29%), making China the second largest exporter of goods to the United States, behind only Canada’s $256 billion export total. At current rates of growth, China will surpass Canada and become the largest supplier of U.S. imports in 2006.

Trade balance by country and commodity, 2004 (millions U.S. $)
       
  2003 2004 Percent change
Goods -547,552 -666,183 21.7%
Services 51,044 48,458 -5.1%
Total -496,508 -617,725 24.4%
       
Good trade balance (Census basis) -532,350 -651,521 22.4%
       
Pacific rim (total) -230,517 -282,534 22.6%
China -124,068 -161,978 30.6%
Japan -66,032 -75,194 13.9%
       
NAFTA (total) -92,319 -110,832 20.1%
Canada -51,671 -65,765 27.3%
Mexico -40,648 -45,068 10.9%
       
Western Europe -100,320 -114,077 13.7%
South/Central America -26,883 -37,323 38.8%
OPEC -51,064 -71,867 40.7%
Rest of world -31,247 -34,888 11.7%
       
Petroleum -120,402 -163,998 36.2%
Non-Petroleum -411,948 -487,523 18.3%
Agricultural commodities 12,108 7,044 -41.8%
Manufacturing trade balance -469,437 -552,074 17.6%
Advanced technology products -26,822 -37,024 38.0%
       
Source: EPI analysis of Census Bureau data.

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 EPI Snapshot, Rapid Current account deficit likely to get worse before it improves). Foreign governments provided 55% of total capital inflows in the first three quarters of 2004, and 81.5% of these inflows were from Asian governments.

The U.S. trade deficit with the Pacific Rim increased 22.6% in 2004, reflecting deep changes in the structure of trade with Asia. The U.S. deficit with Japan increased 13.9%, 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 growth in the trade deficit with China was responsible for less than three-quarters of the growth of the total deficit with the Pacific Rim in 2004, as the bilateral trade surpluses of Japan and other countries in the region continued to grow in 2004.

The U.S. deficit with Western Europe rose 14% in 2004. This increase 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, jumping by a sharp 40% in 2004 and 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 since 1997 (see figure above). The dollar began to rise significantly in 1997 and peaked in 2002, as shown below. Traditionally, after a major decline in a currency, the real trade balance has improved with a lag of less than a year and the nominal trade balance has improved within 18 months. This time, however, the dollar peaked in February 2002, but both the real and nominal trade deficits have continued to deteriorate 11 quarters later. During the trade and dollar crises of the 1980s, the dollar fell much more rapidly (25.4% within 8 quarters) than it has since 2002 (a decline of only 14.1% during a comparable period). To achieve sustainable trade deficit levels, the dollar must fall much more (or U.S. GDP and employment must grow much more slowly).

A 25% fall in the dollar from 1985 to 1988 was required to reduce the real trade deficit from 2.6% of GDP to 1.0% of GDP by 1989. The dollar stayed down in that range through 1997, and the deficit stayed around 1.0% of GDP (except when the recession of 1990-91 pulled the deficit down to zero). Bringing down the 2004 deficit of 5.8% of GDP will require a much larger devaluation of the dollar. Reducing the deficit to a sustainable 1.0% of GDP 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 1987-97 average of 90%. Domestic manufacturing output would have to increase by nearly 19.3% to raise output enough to shrink the trade deficit to a sustainable 1% of GDP and increase the domestically produced share of goods consumed back to the 90% level.

Manufacturing lost 3.3 million manufacturing jobs between February 1998 and December 2004. Although 33,000 jobs have been added in the manufacturing sector in 2004, the manufacturing trade deficit has continued to expand. The U.S. deficit in manufactured goods rose from $470 billion in 2003 to $552 billion in 2004, an increase of 17.6%. Strong growth in domestic demand has been required to offset this continuing decline in international manufacturing competitiveness.

—by EPI Senior International Economist Robert E. Scott with research assistance from David Ratner.

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The Economic Policy Institute TRADE PICTURE is published upon the release of quarterly and year-end trade figures from the Commerce Department.

EPI offers same-day analysis of income, price, employment, and other economic data released by U.S. government agencies. For more information, contact EPI at 202-775-8810.


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