Bernanke aggravates trade deficit risks
By Peter Morici
The growing United States deficit on trade in goods and services, rising to
US$60.9 billion in April from $56.5 billion in March, heightens the risk of
recession and surging unemployment. he recent comments by Federal Reserve Board
chairman Ben Bernanke about oil-driven inflation only serve to distract
attention from these issues and aggravate risks.
The deficit, announced on Tuesday by the US Commerce Department and
substantially larger than the $59.5 billion consensus forecast, was driven up
by higher prices for imported oil and a dramatic surge in imports from China.
At 5.1% of gross domestic product, these pose a significant drag on the
economy.
Simply, money spent on Middle East oil and Middle Kingdom
consumer goods can't be spent on US made goods and services. The drag on
aggregate demand is every bit as important as the credit crisis and housing
adjustment in driving up unemployment. The combined effect of oil imports, the
trade deficit and housing adjustment are pushing the economy into recession and
breaking inflation on non-energy products. That is why core inflation, prices
less food and energy, stays in check.
Bernanke in recent comments has emphasized that Western central banks stand
ready to resist oil-induced recession, when in fact oil price increases are far
beyond the control of the Federal Reserve and other central banks to affect.
This is causing markets to factor in Federal Reserve increases in the federal
funds rate by the end of the year, just as the economy is sliding into
recession.
China is subsidizing oil imports, without regard to spot prices in
international markets, and controlling domestic gasoline prices with the
dollars it purchases with yuan. It undertakes the latter purchases to keep the
yuan undervalued against the dollar and boost exports. Hence, consumers in the
country contributing most to growing demand for oil, China, are wholly
insulated from rising oil prices. As oil prices rise, the Chinese drive prices
even higher with their subsidies. Bernanke should talk about that if he wants
to do something about oil driven inflation.
Instead, Bernanke's words cause markets to believe the Fed will raise interest
rates as we travel into a recession and this drives equity prices down,
compounding the panic created by rising oil prices.
Raising interest rates now would be the kind of policy the Federal Reserve
pursued in 1929. Is that the kind of signal a central banker and student of the
Great Depression wants to send to fragile markets?
If Bernanke wants to do something about both the recession and inflation, he
should focus on Chinese purchases of dollars with yuan, which boost exports to
the United States, and Chinese subsidies on oil imports with those dollars,
which drive up global oil prices. Together, these are driving up the trade
deficit, exacerbating the recession and driving up US gas prices.
Were the Chinese yuan problem solved, the trade deficit could be cut by a
third, and that would boost US gross domestic product (GDP) by about $250
million to $500 billion.
Breaking down the deficit
Together, petroleum, China and automotive products account for nearly the
entire US trade deficit, and no solution to the overall trade imbalance is
possible without addressing these segments.
Petroleum products accounted for $34.5 billion of the monthly trade gap, on a
seasonally adjusted basis, up from $30.2 billion in March. Since December 2001,
net petroleum imports have increased $30.0 billion, as the average price of a
barrel of imported oil has risen from $15.46 to $96.81, and monthly imports
have increased from 353 million to 388 million barrels.
Retuning conventional gasoline engines and transmissions, hybrid systems,
lighter weight vehicles, nuclear power, and other alternative energy sources
could substantially reduce US dependence on foreign oil. These solutions
require national leadership, but both Republican and Democratic Party leaders
have failed to champion policies that would reduce dependence on Middle East
oil.
In 2007, the Congress managed to push through the first increase in automobile
mileage standards in 32 years but don't cheer loudly. The 35 mile-per-gallon
standard to be achieved by 2020 is far less than what is possible.
The bill also requires the production of about 2.4 million barrels a day of
ethanol. Along with other conservation measures, the 2007 Energy Act could
reduce US petroleum consumption by 4 million barrels a day by 2030. Over the
past 23 years, petroleum consumption has increased by about 5.5 million barrels
a day, despite improvements in mileage standards, automobile and appliance
technology, and conservation.
Being optimistic, in 2030 the United States will be just as dependent on
imported oil as before without stronger conservation and alternative fuel
policies. Factor in falling production from US oil fields, the situation gets
worse.
China accounted for $20.2 billion of the April trade deficit, up from $16.1
billion in March and $5.5 billion in December 2001. The bilateral deficit is
rising because China undervalues the yuan, and this makes Chinese exports
artificially inexpensive and US products too expensive in China. US imports
from China exceed exports to China by a ratio of 4.5 to 1.
China revalued the yuan from 8.28 to 8.11 in July 2005 and has permitted the
yuan to rise less than 5% every 12 months. Modernization and productivity
advances raise the implicit value of the yuan much more than 5% every 12
months, and the yuan remains undervalued against the dollar by at least 40%.
China's huge trade surplus creates an excess demand for yuan on global currency
markets; however, to limit appreciation of the yuan against the dollar and
drive its value down against the euro, the People's Bank of China sells yuan
and buys dollars, euros and other currencies on foreign exchange markets.
In 2007, the Chinese government purchased $462 billion in US and other foreign
currency and securities. This comes to about 14% of China's GDP and about 35%
of its exports of goods and services. These purchases provide foreign consumers
with 3.5 trillion yuan to purchase Chinese exports, and create a 35% "off
budget" subsidy on foreign sales of Chinese products, and an even larger
implicit tariff on Chinese imports.
In addition, China provides numerous tax incentives and rebates, and low
interest loans, to encourage exports and replace imports with domestic
products. These practices clearly violate China’s obligations in the World
Trade Organization, and it agreed to remove those when it joined the trade
body.
Automotive products account for about $11 billion of the monthly trade deficit.
Japanese and South Korean manufacturers have captured a larger market and are
expanding their US production. However, Asian manufacturers tend to use more
imported components than domestic companies, and GM and Ford are pushing their
parts suppliers to move to China.
GM, Ford and Chrysler still carry a significant cost disadvantages against
Toyota plants located in the United States, thanks to clumsy management and
unrealistic wages, excessive fringe benefits and arcane work rules imposed by
United Autoworker contracts. Recent negotiations improved the Detroit Three's
cost position but did not wholly close the labor cost gap with Toyota and other
Asian transplants.
Recently negotiated labor agreements should reduce, but not eliminate, these
cost disadvantages. Even with retiree health care benefits moved off the books
and a two-tier wage structure, the cost disadvantage will remain at least
$1,000 per vehicle.
Also, the Bank of Japan has aggressively stepped up sales of yen and won for US
dollars and other securities to keep its currency cheap against the dollar.
This discourages Toyota and others from moving more auto assembly and sourcing
more parts in the United States.
Deficits, debt and growth
Trade deficits must be financed by foreigners investing in the US economy or
Americans borrowing money abroad. Direct investments in the United States
provide only about a tenth of the needed funds, and Americans borrow about $50
billion each month. The total debt is about $6.5 trillion, and at 5% interest,
the debt service comes to about $2,000 per US worker each year.
High and rising trade deficits tax economic growth. Each dollar spent on
imports, not matched by a dollar of exports, shifts workers into activities in
non-trade competing industries such as department stores and restaurants.
Manufacturers are particularly hard hit by this subsidized competition. Through
recession and recovery, the manufacturing sector has lost 3.7 million jobs
since 2000. Following the pattern of past economic recoveries, the
manufacturing sector should have regained more than 2 million of those jobs,
especially given the very strong productivity growth accomplished in
technology-intensive durable goods industries.
Productivity is at least 50% higher in industries that export and compete with
imports. By reducing the demand for high-skill and technology-intensive
products, and US-made goods and services, the deficit reduces GDP by at least
$250 billion a year, or about $1,750 for each worker.
Longer-term, persistent US trade deficits are a substantial drag on growth. US
import-competing and export industries spend at least three times the national
average on industrial research and development, 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 one percentage
point a year, and the trade deficits of the last two decades have reduced US
growth by one 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.
The damage grows larger each month, as the George W Bush 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.
(Copyright 2008 Peter Morici. Used with permission.)
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