EYE ON
AMERICA The great China
sale By Peter Morici
On
Wednesday, the US Commerce Department reported
that the 2006 current-account deficit was US$856.7
billion, up from $791.5 billion in 2005 and
setting a new record. The deficit was 6.5% of
gross domestic product (GDP).
In the
fourth quarter, the current-account deficit was
$195.8 billion, down from $229.4 billion in the
third quarter. The reduction was mostly
attributable to lower oil prices during the latter
months of
2006,
and this situation reversed in the first quarter
of 2007.
The current account is the
broadest measure of the US trade balance. In
addition to trade in goods and services, it
includes income received from US investments
abroad less payments to foreigners on their
investments in the United States. Those net
payments turned negative for the first time in
many decades, confirming that borrowing to finance
huge trade deficits has reduced the world's
largest economy to the status of a debtor nation.
To finance the trade deficit, Americans
are borrowing and selling assets at a net pace of
$856.7 billion a year. Consequently, in 2006, the
United States paid to foreigners more interest,
dividends and profits than it received, recording
a net deficit on income payments of $7.3 billion.
Valuing the net investment position of the United
States is difficult, but this negative flow of
payments is the clearest evidence of the debtor
status of the United States.
The Chinese
government alone holds more than $1 trillion in US
and other securities, and these could be used to
purchase more than 5% of the value of publicly
trade US companies. This should give Americans
real pause about Chinese government intentions to
diversify foreign-exchange holdings.
The
current-account deficit imposes a significant tax
on GDP growth by moving workers from export and
import-competing industries to other sectors of
the economy. This reduces labor productivity,
research-and-development (R&D) spending, and
important investments in human capital.
Anatomy of the hemorrhaging In
2006, the United States had a $70.7 billion
surplus on trade in services. This was hardly
enough to offset the massive $836.0 billion
deficit on trade in goods and $7.3 billion deficit
on income flows. Also, unilateral transfers
contributed $84.1 billion to the overall
current-account deficit.
In 2006, the
deficit on petroleum products was $271.0 billion,
up from $229.2 billion in 2005; prices for
imported petroleum rose about 23.9% from 2005,
while the volume of imports rose 19.6%.
The US appetite for inexpensive imported
consumer goods and cars was a huge factor driving
the trade deficit higher. In 2006, the deficit on
non-petroleum goods was $547.0 billion, up from
$538.3 billion in 2005.
The deficit on
motor-vehicle products increased 5.5% to $144.7
billion, as Ford and General Motors continue to
push their procurement offshore and cede market
share to Japanese and South Korean companies
offering better-made and less expensive vehicles.
Even when they assemble automobiles in the United
States, Asian auto makers import more parts than
Ford and GM do.
The Wal-Mart effect was
broadly apparent. In 2006, the trade deficit with
China was $232.7 billion, a new record. This was
up from $201.7 billion in 2005.
This
situation is likely to become worse in the months
ahead. Crude-oil prices are rising again, and an
overvalued US dollar continues to keep imported
cars and consumer goods cheap. Announced
production cutbacks at GM, Ford and Chrysler will
result in more imported motor vehicles and parts.
Rising gasoline prices are driving car buyers away
from Detroit's gas-guzzlers and into the arms of
Asian brands.
The dollar remains at least
40% overvalued against the Chinese yuan and other
Asian currencies. 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
very closely. Currently it is trading at 7.74.
Other Asian governments must conform their
currency policies to China, lest they lose
competitiveness in the US and European markets. To
sustain undervalued currencies against the dollar,
foreign governments purchased $300.5 billion in US
securities in 2006. This created a 14% subsidy on
their exports to the United States.
Financing the deficit The
current-account deficit must be financed by a
capital-account surplus, either by foreigners
investing in the US economy or their lending
Americans money. Some analysts argue that the
deficit reflects US economic strength because
foreigners find many promising investments in the
United States. The details of US financing belie
this argument.
In 2006, US investments
abroad were $1,045.8 billion, while foreigners
invested $1,764.9 billion in the United States. Of
that latter total, only $183.6 billion, or 10.4%,
was direct investment in US productive assets. The
remaining capital inflows were foreign purchases
of Treasury securities, corporate bonds, bank
accounts, currency, and other paper assets. In
essence, Americans borrowed $1.6 billion to
consume 6.5% more than they produced.
Foreign governments lent Americans $300.5
billion, or 2.3% of GDP. That well exceeded net
household borrowing to finance homes, cars,
gasoline and other consumer goods. The Chinese and
other governments are in essence bankrolling US
consumers, who in turn are mortgaging their
children's income.
The cumulative effects
of this borrowing are frightening. The total
external debt now exceeds $6 trillion. That comes
to $20,000 for each American, plus interest.
The Chinese government alone holds enough
US and other foreign reserves to purchase more
than 5% of the shares of all publicly traded US
companies, and that figure increases by 20% each
year. The US trade deficit is the primary driver
behind this phenomenon.
Consequences
for economic growth High and rising trade
deficits tax economic growth. Specifically, each
dollar spent on imports that is not matched by a
dollar of exports reduces domestic demand and
employment, and shifts workers into activities
where productivity is lower.
Productivity
is at least 50% higher in industries that export
or compete with imports, and reducing the trade
deficit and moving workers into these industries
would increase GDP.
Were the trade deficit
cut in half, US GDP would increase by nearly $250
billion, or about $2,000 for every working
American. Workers' wages would not be lagging
inflation, and ordinary working Americans would
more easily find jobs paying higher wages and
offering decent benefits.
Manufacturers
are hit particularly hard by this subsidized
competition. Through recession and recovery, the
manufacturing sector has lost 3.2 million jobs
since 2000. Following the pattern of past economic
recoveries, the manufacturing sector should have
regained about 2 million of those jobs, especially
given the very strong productivity growth
accomplished in durable goods and throughout
manufacturing.
Longer-term, persistent US
trade deficits are a substantial drag on growth.
US import-competing and export industries spend
three times the national average on industrial
R&D, and encourage more investments in skills
and education than other sectors of the economy.
By shifting employment away from trade-competing
industries, the trade deficit reduces US
investments in new methods and products, and
skilled labor.
Cutting the trade deficit
in half would boost US GDP growth by 1 percentage
point a year, and the trade deficits of the past
two decades have reduced US growth by 1 percentage
point a year.
Lost growth is cumulative.
Thanks to the record trade deficits accumulated
over the past 10 years, the US economy is about
$1.5 trillion smaller. This comes to about $10,000
per worker.
Had the administration and
Congress acted responsibly to reduce the deficit,
American workers would be much better off, tax
revenues would be much larger, and the federal
deficit could be eliminated without cutting
spending.
The damage grows larger each
month, as the administration dallies and ignores
the corrosive consequences of the trade deficit.
Peter Morici is a professor at
the University of Maryland School of Business and
former chief economist at the US International
Trade Commission.
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