On Tuesday, the US Commerce
Department reported that the July deficit on trade
in goods and services was US$68 billion, up from
$64.8 billion in June and surpassing the record
$66.3 billion set in January.
The
petroleum deficit rose to $25.6 billion in July,
up from $24.5 billion in June.
The trade
deficit with China was $19.6 billion in July, not
much changed from $19.7 billion in June. However,
China reported a
record monthly trade surplus
for August, indicating the US deficit with China
will grow further in the months ahead.
Near-term, the ballooning trade deficit
will tax third quarter growth by about two-tenths
of a percentage point. Longer term, it slows
investments in research and development-intensive
(R&D)export-oriented industries.
Moreover, trade deficits must be financed
by foreigners investing in the US economy or
lending Americans money. Direct investment in
property and productive assets provides only a
small portion of the needed funds, and the balance
is obtained through the sale of Treasury
securities, corporate bonds, bank accounts and
other paper assets. Americans borrow nearly $60
billion each month to consume more than they
produce. The total debt will exceed $6 trillion by
the end of 2006.
Oil, currency and
China Since December 2001, the trade
deficit has increased by $41.4 billion. Net
imports of petroleum account for 48% of the
increase in the trade deficit. Increased US
imports of consumer goods, automobiles, business
equipment, and industrial components and
materials, especially from Asia, account for 52%.
The trade deficit with China, alone, has increased
$14.1 billion.
In large measure, the trade
deficit remains stubbornly high, because the
overvalued dollar pushes up imports of Chinese and
other Asian manufactures and handicaps US exports
of durable goods and high-end services.
As
computed by the Federal Reserve Bank, the average
value of the dollar peaked against other
currencies in February 2002. Since that time, the
dollar has declined about 17%. The dollar is down
28% against the euro and other
industrialized-country currencies but only 2%
against the Chinese yuan and other
developing-country currencies combined.
China continues to peg its currency
against the dollar. Although China revalued the
yuan from 8.28 to 8.11 in July 2005 and announced
it would adjust the currency to a basket of
currencies, the yuan continues to track the dollar
closely and currently is trading at about 7.95.
To limit appreciation of the yuan against
the dollar, the Chinese central bank purchases
more than $200 billion in US and other foreign
securities each year. This comes to about 9% of
China's gross domestic product and about
one-quarter of its exports. These purchases
provide foreign consumers with 1.6 trillion yuan
to purchase Chinese exports, and create a 25%
subsidy on foreign sales of Chinese goods.
The competitive advantage this affords
Chinese exports impels other Asian governments to
similarly manage their currencies, to limit their
loss of market share in the United States.
US manufacturers are particularly hard
hit. China's currency market intervention creates
a 25% subsidy on its exports, and competitive
advantages in industries not dependent on low-wage
labor. Other Asia economies follow suit with
similar industrial policies.
Through
recession and recovery, the US manufacturing
sector has lost 3 million jobs. Following the
pattern of past economic recoveries, the
manufacturing sector should have regained about 2
million of these jobs, especially given the very
strong productivity growth accomplished in the
durable goods and throughout manufacturing.
This situation is likely to worsen.
Although the underlying value of the yuan rises at
least 5% each year, China is permitting the yuan
to appreciate less than 2% a year. Hence, the
dollar will remain at least 40% overvalued against
the Chinese yuan, and significantly overvalued
against other Asian currencies too.
Trade deficits and growth
Increased trade with China and other Asian
economies should raise US gross national product
and incomes by shifting demand from
import-competing activities to export industries,
where worker productivity and wages are highest.
Instead, the growing trade deficits with
China and other Asian economies have shifted US
employment from both import-competing and export
industries to nontradable services, like the
retailing and hospitality industries, where worker
productivity and wages are lowest. Were the
Chinese yuan revalued and the trade deficit cut in
half, America's GDP would increase about $300
billion or $2,000 for every worker.
Individual industries are particularly
hard hit. Since 2000, US manufacturing has shed
about 3 million jobs. Judging from past business
cycles, it should have regained about 2 million of
those during this recovery. Trade deficits were
likely responsible for the loss of 2 million
manufacturing jobs, and superior productivity
growth in manufacturing the other 1 million.
Also, import-competing and export
industries spend more than three times as much on
R&D per dollar of value added than the private
business sector as a whole. Cutting the trade in
half would boost R&D enough to accelerate US
productivity and GDP growth at least one
percentage point a year. That would amount to more
than a 25% increase in potential growth.
The trade deficit has been taxing growth
for most of the last two decades, and the
cumulative consequences are enormous. Had foreign
currency-market intervention and large trade
deficits not robbed this growth over the past two
decades, GDP would likely be 20% greater, than it
is today.
Politics, protectionism and
the trade deficit Treasury Secretary Henry
Paulson urgently needs to persuade China to
significantly revalue the yuan; however, President
George W Bush has been reluctant to give his
treasury secretary the levers that could move
China to action.
At International Monetary
Fund-World Bank meetings, Paulson will again seek
progress from Chinese leaders on currency reform.
The American approach has been to try to persuade
China that revaluing the yuan to reflect market
fundamentals best serves its interests. But China
views these issues through mercantilist lenses.
An undervalued yuan permits China to
create employment for underutilized rural workers
on export platforms, and to provide competitive
space for inefficient state-owned enterprises to
modernize. Chinese economic growth exceeds 10% and
inflation is about 2%. China may want to cool
growth a bit, but it is not about to give up its
most powerful development tool - an undervalued
yuan.
Subsidizing Chinese exports with an
undervalued currency is nothing more than high
profit protectionism that harms the US economy;
however, President Bush refuses to make
protectionism costly to China and instead has
chosen the path of appeasement. The Chinese sense
weakness and exploit it.
For example, the
Bush administration opposes a bipartisan bill
sponsored by Congressmen Duncan Hunter and Tim
Ryan that would add the subsidies provided by
currency manipulation to the list of unfair trade
practices actionable under US countervailing duty
law, and permit domestic manufacturers to petition
the Department of Commerce and the US
International Trade Commission for duties on
Chinese imports to offset these subsidies.
Bush's reluctance to tackle currency
issues and other industrial policies unfairly
advantaging industries in Asia will harm
Republicans in the fall elections. Many of the
manufacturing jobs lost to subsidized imports are
in swing districts in western in Ohio, Indiana and
elsewhere along the ridge line between red
(Republican) America and blue (Democratic)
America.
The president's reluctance to
address the root cause of job losses in these
communities could cost Republicans their majority
in the House of Representatives. They will not
have to look far for the policies and man
responsible.
Peter Morici is a
professor at the University of Maryland School of
Business and former chief economist at the US
International Trade Commission.
