Trade: Realities and Fallout

I want everyone to forget the first sentence of last week’s column. Things are not scary; they’re bordering on out of control on several fronts. In particular, there are two items which are getting nearly no press that urgently need to be discussed. While the media world continues to focus on whether or not Fannie Mae (FNM) and Freddie Mac (FRE) have another 12 hours of solvency left, our trade deficit continues to persist despite continued weakness in the Dollar and out of control import prices. I like to use these two macro measures as a barometer of not only what is going on now, but what is likely to happen down the road.

Import Prices 

Since our last analysis of import prices in May, we have seen matters continue to get worse. In the few mainstream news pieces which actually refer to import prices, the blame has been laid solely at the feet of crude oil. So, in the spirit of fairness, I am including a chart of ‘headline’ import prices as well as ‘core’ import prices (ex petroleum).

  

Granted, petroleum prices have been volatile even as they trend higher. Now look at the same series with petroleum imports taken out. See a trend here?

 

Even with petroleum products removed, we are moving higher, and quickly. With annual increases of 5-15%, it is easy to see how Main Street’s 3.6% average wage growth just doesn’t keep up. Throw in petroleum and the picture gets a whole lot worse. 

Trade Deficit 

Despite the fall in the Dollar over the past 12 months, our trade deficit continues to get worse. Pundits have pointed out that April 2008 exports set an all-time record. However, they failed to note that imports also set an all-time record. It also must be noted that imports and exports are calculated in Dollars spent; not the quantity of goods. With import prices rising rapidly, what this is saying to us is that we’re getting fewer goods for the same money. This is directly attributable to the falling Dollar:

 

In July 2007, the US Dollar Index was at 81. Today, the index is at 72.50, a loss of 10.5%. During the same period, the accumulated trade deficit has been a staggering $637 BILLION dollars. So as our Dollar has lost its purchasing power, our debts to foreigners have increased by nearly two thirds of a trillion dollars. This is exactly what I expected would happen as outlined in the 9/28/2007 missive Economic Myth Busters Vol. 2. Clearly we are no better for the fall in the US Dollar; we are far worse. 

Analysis of these two measures tells us a few things. First and foremost, it tells us that the US consumer is under extreme pressure from prices and will remain so for the foreseeable future. This isn’t going away; it is getting worse. This reality will translate into reduced sales of discretionary goods, particularly since credit is being withdrawn from a good portion of these consumers.

As the snowball gains momentum, reduced sales will translate into reduced earnings for discretionary companies and subsequent lower stock prices. To frame this for Main Street, they will see prices of goods and services continue to rise as the money supply is inflated to bail out Wall Street. However, by the mechanism described above, many of their paper investments will continue to lose value. This at the same time as their homes continue to depreciate in value, causing what have become necessary credit lines to be either reduced or cut off completely. 

The persistent trade deficit tells us that there is a continued outflow of funds from the US as we are required to borrow more and more money from overseas to pay for imports. When the Dollar’s decline first got the attention of the mainstream press last year, we were assured that a falling Dollar was good for exports, which to a certain extent it has been. However, they forgot to consider the other side of the equation. A falling Dollar means we have to pay more for our imports and since we have done almost nothing to change our reliance on such imports, the concomitant rise in import costs has wiped out any benefit of increased exports.

So in the end, Main Street gets a weaker Dollar, unchanged trade deficits, skyrocketing import prices, falling asset markets and consumer price increases that not only show no signs of abating, but continue to get worse. Talk about getting the short end of the stick.

So what can we do about it? Again, I refer to a prior article, penned on 9/14/2007 entitled Beat the Bust. The simple strategies outlined in that article are still in play. Comparing then and now validates those strategies. Comparing then and the future makes them absolutely invaluable.

Comments

[messy:]

I have a question on TRADE DEFICITS, With many factories close and all clothing factories in foreign lands, when does this author believe that the USA will reach an equal point between exports and imports?
To me its centuries away, until we start producing like we did in the WW1 AND WW2 ERA. The world economy and our government has changed all that,,,we desire to send our money to Communist China and Asia where there is cheap labor.

2008 Jul 13 08:13 AM

[Pete Murphy:]

Andy, the falling dollar has had no impact on reducing the trade deficit (contrary to predictions by economists) because currency valuations have nothing to do with the deficit. The trade deficit is rooted in granting free access to the U.S. market to grossly overpopulated nations who have no equivalent market to offer in return. Without a return to tariffs in such situations, the trade deficit is automatic and irreversible, tantamount to economic suicide.

In interested in learning more about an important new economic theory, please visit either of my web sites at OpenWindowPublishingCo... or petemurphy.wordpress.c....

Pete Murphy
Author, Five Short Blasts

2008 Jul 13 08:40 AM

[bbzz24:]

messy,
clothing was first outsourced to china. now it it too expensive there and moved to vietnam & philippines. it takes a few stiching machines and big sylos as fixed investments, the rest is easy.

what is more alarming is the inadvertently lost ability to produce electronics, light machinery, automobiles etc. the country simply lacks any engineering brainpower(everone wants to be an actor/realtor/lawyer). and those industries on top of that are capital intensive.

2008 Jul 13 08:49 AM

[Ames Tiedeman:]

The dollar should see a complete and total collapse. One must have balanced trade or their currency will become worthless. We played the trade deficit game sine 1974. It has failed.

2008 Jul 13 10:05 AM

[Jim Hawthorne:]

Thanks for a great article, Andy! (again)
Not only have we lost what we had, we are furiously trading off the building blocks of our kids' futures!

2008 Jul 13 11:06 AM

[Old Wizard:]

Your article raises the right issue. I think that balance of trade is only one of the two terms in the current account which is a true measure of the country's cash flow from operations. The other term is the net balance of positive cash flow from investments domestic co. have abroad and foreign co/gov. have in the U.S.. For some period of time, the second term compensated for the negative balance of trade. At this time that second term is also negative and increases negatively every time a domestic co. with any overseas profitable business, is bought by a foreign investor. Given the fact that we are now spending app. $700b for imported oil, it is not only a stategic military issue, but also an economic survival one that we 1] produce more oil domestically, satisfy our energy needs by developing alternative sources, and keep our domestic multi-national companies located in the USA. All these must be done on crash basis. There is no other solution which will drive the current account to 0 any more quickly. What if we didn't import any oil today? Wouldn't we have a positive trade balance and proably a positive current account?

2008 Jul 13 01:45 PM

[Old Wizard:]

Your article raises the right issue. I think that balance of trade is only one of the two terms in the current account which is a true measure of the country's cash flow from operations. The other term is the net balance of positive cash flow from investments domestic co. have abroad and foreign co/gov. have in the U.S.. For some period of time, the second term compensated for the negative balance of trade. At this time that second term is also negative and increases negatively every time a domestic co. with any overseas profitable business, is bought by a foreign investor. Given the fact that we are now spending app. $700b for imported oil, it is not only a stategic military issue, but also an economic survival one that we 1] produce more oil domestically, satisfy our energy needs by developing alternative sources, and keep our domestic multi-national companies located in the USA. All these must be done on crash basis. There is no other solution which will drive the current account to 0 any more quickly. What if we didn't import any oil today? Wouldn't we have a positive trade balance and proably a positive current account?

2008 Jul 13 01:45 PM

[semar:]

well, the Fed just released a paper saying the account deficit is by far sustainable.

Probably it just doesn't bother them, anything else I can't say...

2008 Jul 13 01:52 PM

[Urbane Gori...:]

To messy and bbzz24:

Keep in mind that one of McCain's closest advisors is Carly Fiorina... The ex CEO of Hewlett Packard fame. Ms. Fiorina keeps popping up like the proverbial bad penny. She was and still is a major proponent of outsourcing our industries to foreign countries. To paraphrase her, "Sure. American businesses are being sent overseas, and Americans are losing their jobs, homes and standard of living because of it. But, this loss of American manufacturing is benefitting us all. After all, look how cheap products have become." As a lifelong Republican... Until the last administration, I have serious doubts about McCain's choice of advisors.

Thx jegan ;-)

2008 Jul 13 03:08 PM

[X-15:]

The United States budget woes-9.2 trillion deficit- is the great concern. Were the USA to begin to address this,hell, at least give it serious lip service along with opening up the massive areas we have left for Oil production would do a lot to stave off dollar decline. Then put a 10 billion prize out there to whomever can propel an 18 wheeler with 80,000 gross weight at 4x the average 6 mpg.

2008 Jul 13 10:38 PM

[Brian27:]

The US has run a trade deficit every year since 1976. In that time the dollar has appreciated and depreciated. Obviously trade deficits do not cause dollar depreciation.

All the balance of trade deficit shows is that the US borrows from the rest of the world. And Why? Because Americans expect future incomes to rise faster than the debt on the borrowing. The European countries that run trade surpluses have all had low rates of economic growth. Therefore, they have to save to improve future incomes.

Faster economic growth and superior investment opportunities in the US have lead to trade deficits with the rest of the world.

The US trade and current accounts are determined by aggregate savings behaviour.

www.census.gov/foreign...

2008 Jul 13 11:36 PM