Rising Trade Deficit Doesn't Bode Well for Long-Term Recovery

by: Peter Morici
The Commerce Department reported the April deficit on international trade in goods and services increased to $40.3 billion from $40.0 billion in March.
The trade deficit, along with the credit and housing bubbles, were the principal causes of the Great Recession. Now, a rising trade deficit and continued weakness among regional banks, still burdened by bad loans, threatens to stifle the emerging recovery and keep unemployment near 10% through 2011.
At 3.3% of GDP, the trade deficit subtracts more from the demand for U.S.-made goods and services than President Obama’s stimulus package adds to demand. Moreover, Obama’s stimulus is temporary, whereas the trade deficit is permanent and growing again.
Subsidized manufactures from China and petroleum account for nearly the entire deficit, and both will rise as consumer spending and oil prices rise through 2010.
Money spent on Chinese coffee makers and Middle East oil cannot be spent on U.S.-made goods and services, unless offset by exports.
When imports substantially exceed exports, Americans must consume much more than the incomes they earn producing goods and services, or the demand for what they make is inadequate to clear the shelves, inventories pile up, layoffs result, and the economy goes into recession.
To keep Chinese products artificially inexpensive on U.S. store shelves and discourage U.S. exports into the Middle Kingdom, China undervalues the yuan by 40%.
Beijing accomplishes this by printing yuan and selling those for dollars to augment the private supply of yuan and private demand for dollars. In 2009, those purchases were about $450 billion, or 10% of China’s GDP, and about 35% of its exports of goods and services.
In 2010, the trade deficit with China is reducing U.S. GDP by more than $400 billion, or nearly 3%. Unemployment would be falling rapidly and the U.S. economy recovering more rapidly but for the trade deficit with China and Beijing’s currency policies.
Longer term, China’s currency policies reduce U.S. growth by one percentage point a year. The U.S. economy would likely be $1 trillion larger today, but for the trade deficits with China over the last 10 years.
China has indicated it will not revalue its currency at this time. Some analysts expect only a gradual revaluation if any change in policy occurs—perhaps a few percentage points a year. Such a move would have little consequence for the U.S. trade deficit, unemployment and growth.
China views its exchange rate policy as a tool of domestic development strategy but its policy has broad, aggressive and negative international consequences—it is choking growth and imposing high unemployment on the United States and other western countries.
Diplomacy has failed, and President Obama should impose a tax on dollar yuan conversions in an amount equal to the amount of China currency market intervention divided by its exports—currently that would be about 30%. For imports, at least, that would offset China’s subsidies that harm U.S. businesses and workers.
After diplomacy has failed for both Presidents Bush and Obama, failure to act amounts to no more than appeasement, and wholesale neglect of President Obama’s obligations to advocate a level playing field for U.S. workers.
Disclosure: No positions