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Originally Published: 11/29/2006

THE TRADE DEFICIT

By The Issue Wonk

 

Introduction

 

The United States has, for many years, been trading with other countries in such a way that leaves us with a trade deficit. A trade deficit means that the dollar amount of goods and services sold by Americans to foreigners is less than the dollar amount of goods and services purchased from foreigners. (See U.S. Trade Policy.) In other words, we’re purchasing more than we’re selling. And the deficit has been growing. According to Balance of Payments Table produced by the U.S. Census Bureau, Foreign Trade Statistics, in 2000 it was $377,559. That's $377 billion. In 2003 it was $494,897. And in 2005 it was $716,730. In fact, the last time the balance of trade was not a deficit was in 1970. “In 2005, the United States exported only 53 cents’ worth of goods for every dollar it spent on imports. To pay for the excess of imports over exports, the U.S. has to sell stocks, bonds and businesses to foreigners. . . [W]e’ve borrowed more than $3 trillion just since 1999.”1

 

How much is the trade deficit currently? The Trade Ticker gives “up to the minute” calculation of the trade deficit. As of this writing, the trade deficit is $714,581. And, according to the Bureau of Economic Analysis, in the third quarter of 2006 (the most current number available) the GDP is 13,308.3. (That’s 13 trillion dollars.) Therefore, the trade deficit is approximately 5.37% of the GDP. While you may find the trade deficit being reported in quarterly segments or even monthly, it is usually calculated annually, so the amount is $0.00 on January 1st of each year. (Trade Ticker)

 

Most economists believe that a trade deficit that is less than 5% of the Gross Domestic Product (GDP) is acceptable, but that any more than that is "unsustainable in the long run.”2 America's trade deficit has been growing by about $100 billion annually. “It's clear that the U.S. trade deficit cannot go on galloping ahead $100 billion a year indefinitely,” says Daniel Griswold, a trade expert at the Libertarian Cato Institute in Washington.3 Trumbull says, “[T]he gap between what America imports and what it exports is growing so rapidly and relentlessly that it is provoking new concern about how long the world’s largest economy can play borrower and consumer to the world.”3 And Swann and Alden say: “Although U.S. exporters put in a strong performance, raising overseas sales by $2.8 billion to $114.4 billion [in January 2006], they were unable to keep pace with the blistering pace of import growth. Imports were up $6.2 billion to $182.9 billion.”4

 

A prolonged trade deficit raises the specter of economic consequences, one of which is the possibility that foreigners might begin to “dump the dollars they hold in world currency markets.” (Trade Ticker) Charles McMillion, an economist who follows trade patterns at MBG Information Services in Washington, said, “We’re hollowing the economy out. It’s having enormous negative consequences for families and individuals.”3    

 

What Is the Cause of a Trade Deficit?

 

The U.S. is the world’s favorite place for foreign investment. We import massive amounts of capital because we don’t save enough to finance all the available investment opportunities in our economy. This inflow of capital from abroad allows us to pay for the imports that exceed what we export. But what are we importing and where are we importing from? The trade imbalance is usually analyzed with regard to our trade with other countries and with regard to products that are purchased and sold. “Yet virtually across the board, from Europe to Latin America to Africa, the U.S. trade imbalance rose at double-digit rates between 2004 and the end of 2005. It’s difficult to find nations – Australia and Belgium are two – that buy more goods from America than they sell.”3 However, most blame for the deficit is usually placed on China and petroleum. “The monthly record is attributed to a surge in goods from fast-rising China, a tide of imports affecting the beleaguered U.S. auto industry, and an exodus of dollars going to pay for OPEC oil.”3

 

According to Weller2 there are “[s]everal long term factors evident since March 2001 [which] are responsible for the growing trade deficit:

 

Growing energy dependence:  A growing appetite for petroleum imports, which totaled $20.0 billion in March 2006 and $65.2 billion in the first quarter (of 2006), up from $26.6 billion in the first quarter of 2001, highlights the nation’s growing dependence on foreign energy sources.

 

Weaker demand for U.S. high technology exports:  The Census Bureau reports a deficit of $7.2 billion in the first quarter of 2006 compared to a surplus of $4.6 billion in the first quarter of 2001.

 

Weaker demand for U.S. services:  Trade in services such as education and tourism have widened the U.S. trade deficit. A surplus of $13.9 billion in the first quarter of 2006 compares to a surplus of $18.1 billion in the first quarter of 2001.

 

Growth of foreign borrowing keeps dollar high and broadens deficit:  High budget deficits have forced the U.S. to borrow money overseas, which in turn has kept the dollar high. Although the dollar has fallen this year against most major currencies, its decline has been slower than otherwise would have been the case because of the budget deficit. A high value of the dollar makes U.S. exports more expensive abroad. In addition, managed exchange rates in some parts of the world, such as China, have also impeded export growth and contributed to the flood of imports.

 

The concern about trade with China permeates everything you read about the trade deficit. “The sensitive bilateral trade deficit with China climbed to $17.9 billion in January from $16.3 billion . . .”4 “At $201 billion last year, China’s trade surplus in goods with the U.S. was by far the largest of any nation. That figure represents a 24% rise in just 12 months, fueled by surging exports of everything from textiles to electronics.”3 In April Iritani and Lee said that the trade deficit with China might be as high as $250 billion by the end of the year.5

 

What Happens When It’s Too Much?

 

One problem the U.S. faces when the trade deficit is high is that it signals the erosion of America’s economy. Large trade deficits due to U.S. consumers buying cheaper goods from abroad translates to fewer jobs here at home.3 Also, if you look at trade deficits as being a result of foreign ownership of our national debt, “you see that we’re increasingly beholden to the very countries whose markets we’d like to open to American goods.”4 Of course, opening markets to American goods increases production, and thus jobs, here at home. In fact, according to the Trade Ticker:

 

Thousands of U.S. layoffs occur every week. You only have to look at AmericanEconomicAlert.org’s news section to see the number of U.S. jobs that are being cut across a wide range of industries. A high percentage of these layoffs are as a direct result of competition from foreign companies. Eventually, as more and more money leaves the U.S., our businesses will be powerless to prevent further such activity.

 

However, when the trade deficit is viewed in relation to the national debt, “Other nations may at some point decide they don’t want to invest so heavily in U.S. dollar-denominated assets, from Treasury bonds to businesses. That could weaken the exchange rate of the dollar, which in turn would help U.S. exporters. [But] America may have to pay higher rates of interest to lure foreign financing, such as borrowing to cover growing federal budget deficits.”3 So, lowering the trade deficit, while good for U.S. producers and their employees, could bring a weaker dollar and higher interest rates.

 

How Can the Trade Deficit Be Reduced?

 

Assuming that it’s desirable to pay the price in higher interest rates in order to provide jobs for our citizens, what can be done to reduce the trade deficit? Some changes to our trade policy aimed at reducing the trade deficit with China is one answer. It is believed that China has been manipulating its currency to keep its value artificially low. U.S. manufacturers say the Chinese yuan is undervalued by as much as 40%, giving its exporters an unfair advantage.”5 “The dreams of U.S. manufac-turers and labor unions for a higher yuan, however, are difficult for China to fulfill. While some currency analysts expect Beijing will allow the yuan to strengthen, a shift that is too sudden or too dramatic – producing a surge of imports into China – could spark social unrest among Chinese farmers and workers whose livelihoods would be negatively affected.”3 “Chinese officials fear that rapid currency appreciation would invite speculators, trigger an outflow of funds and hurt export industries that provide badly needed jobs.”5 Nevertheless, some lawmakers have threatened to place tariffs on Chinese imports or restrict U.S. government-backed loans to China unless Beijing takes more aggressive action on currency reform.5

 

When it comes to goods and services, however, many of the issues, especially the incredibly complicated ones, will probably end up with the World Trade Organization.  (WTO) “The U.S. and the European Union asked the WTO last month (March, 2006) to look into China’s taxes on imported auto parts. The U.S. also has said it may file a complaint over China’s lax enforcement of intellectual property rights if that situation fails to improve.”5

 

Many solutions have been proposed. It may take all of them to rein in the deficit, solutions that may have peripheral benefits other than just increasing jobs. Weller has opined that “Greater emphasis on energy independence, investment in innovation, attention to the declining services trade surplus, government fiscal discipline, and engagement with China on exchange rates are all key elements of the multi-pronged approach.”2

 

It’s a difficult issue and, as with most economic issues, there’s little agreement on what to do and when to do it. However, some things are very clear. The trade deficit is simply a mirror reflection of the larger macroeconomic world, where investment in the United States exceeds our domestic savings. If we want to change the U.S. trade deficit we must change the rate at which Americans save and invest.

 

Summary

 

I’m not an economist and I’m sure I’ll be hearing from all the economists out there. I've just done the research and attempted to put it in an understandable format. But let me take a stab at putting this stuff in a nutshell. When the value of the dollar is high, its exchange rate deters foreigners from buying our goods and services because they cost too much. Thus, we have a trade deficit. However, because the value of the dollar is high, foreigners do invest in the United States (stocks, bonds, Treasury notes, property, etc.) This is one reason we’ve been able to sustain a high trade deficit, but it also means that much of our national debt is held by foreign entities. A weaker dollar will increase U.S. production and result in more U.S. jobs. Foreigners will purchase our goods and services, reducing the trade deficit but also reducing their investments. Then we’d have to raise our interest rates in order to attract foreign investment to fund our annual budget deficits. (See The Budget Deficit and The National Debt.) But, if U.S. citizens increase their saving and investment rate, we can fund our own deficits and not have to raise interest rates. Or, if we do raise interest rates, the interest will be paid to us.

 

__________

 

1  Krugman, Paul. CSI: Trade Deficit. The New York Times, April 24, 2006.

 

2  Weller, Christian E. No Easy Solutions for Chronic U.S. Trade Deficit. Center for American Progress, May 12, 2006.

 

3  Trumbull, Mark. Giant Trade Gap: No End in Sight. The Christian Science Monitor, March 10, 2006.

 

4  Swann, Christopher and Alden, Edward. U.S. Trade Deficit Widens to Record $68.5bn. The Financial Times, March 9, 2006.

 

5  Iritani, Evelyn and Lee, Don. U.S. and China Still Must Resolve Key Trade Issues. Los Angeles Times, April 24, 2006.

 

 

© The Issue Wonk 2006

 

 

 

 

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