Trade Deficits: The Cause of Our Economic Troubles

Armen Hareyan's picture

Many of the most serious economic problems facing the U.S. today are the result of the trade deficits of the past 2½ decades which exploded from $96.2 billion in 1996 to $708 billion in 2007, equivalent to the output (value-added) of 6.4 million industrial workers. Nor are they disappearing. In February, 2008, the trade deficit amounted to $62.3 billion and the decline in manufacturing employment was 52,000.

The number who lost their factory jobs in the past twelve months was 300,000. The effects of the trade deficits include the collapse of the dollar, the decline of manufacturing and the consequent loss of millions of well-paid manufacturing jobs, stagnant wages and the worsening distribution of income, our sluggish economy, soaring oil and commodity prices, and volatile stock market and real estate market behavior.

It is a problem we are going to have to deal with. Because the trade deficits have gone on so long, there is no easy solution. Anything we do will incur heavy costs. Our solution, we believe, is the least costly.

Is it true that the trade deficits are really the cause of these problems? Let’s take a look.

1. The falling dollar. When we import more than we export, foreigners earn US dollars. Converting those dollars into their own currencies in the foreign exchange markets increases the supply of US dollars and causes the dollar to fall relative to other currencies. In 2000, a dollar was valued at 1.05 Euros; in 2008, it was valued at 0.64 Euros, a forty percent drop.

Some countries including China, Japan, and some oil-exporting countries do not sell their dollars in foreign exchange markets, which would lower the value of the dollar relative to other currencies but use them to buy U.S. Treasurys and other financial assets which results in no change in the value of the dollar relative to their own currencies. If they bought American goods with those dollars, the dollar would be strong. But they don’t. In effect, they lend us the dollars they earned so that we can buy more of their goods. In our book, Trading Away Our Future, we call this practice dollar mercantilism because, like 18th century mercantilism, where the desire was to accumulate gold, it is designed to accumulate dollar assets. This leaves exchange rates unchanged, thus keeping their exports cheap to Americans and American goods expensive to their own citizens, perpetuating their trade surplus. In 2000, a dollar was valued at 8.3 Chinese yuan and in 2008 7.0 yuan, a fall of nineteen percent not nearly what the growing Chinese surplus, 83.3 in 2000 versus $232 billion in 2006, an increase of 178 percent, would appear to require.

Nevertheless, we believe devaluation of the dollar is a poor way to try to restore a long-term chronic trade balance for a variety of reasons both economic and political, spelled out in the afore-mentioned book.

2. The de-industrialization of the U.S. As the trade deficits grew, many American products ceased to be produced in the U.S. Whole industries were shut down. Industrial employment fell from 18.2 million in 1996 to 14.0 million in 2006, a loss of 4.2 million jobs, a decline of 23 percent. By contrast, industrial employment from 1987 to 1996 fell only 2.3 percent. Moreover, the evident inability of the U.S. to stem foreign competition or stimulate exports has discouraged American businesses from building new or expanding existing production facilities in the U.S. Investment by businesses in new plant and equipment in 2007 barely exceeded the allowances for depreciation.

3. The worsening distribution of income in the U.S. As a result of the decline in manufacturing, the millions of factory workers who lost their jobs were forced to compete for jobs elsewhere in the labor market. This increased the supply of workers looking for jobs and brought downward pressure on wages throughout the economy. Not everyone lost as a result of the trade deficits. Those whose wages were not determined competitively like government employees, seniors on fixed incomes, etc., benefited from the lower prices of imports. Another group which benefited was the investors in banks and investment firms who administered foreign investments in the stock and bond markets and banks, and of course shareholders.

Some economists argue that the decline of the manufacturing sector is natural, the effect of increased consumption of services relative to goods. But our imports consisted of goods overwhelmingly, including sophisticated products like computers. Our deficit of goods in 2007 amounted to $826.5 billion, while we had a trade surplus in services of $119 billion. We may be producing fewer manufactured goods but we are consuming more. Were trade in balance, many of those goods would be produced here and the manufacturing sector would not be in free-fall.

4. Slow economic growth. As Keynes pointed out and as all schools of economics agree, the engine of economic growth is investment. Exports work similarly to stimulate the economy. However, Keynes cautioned against using tariffs and other trade barriers to gain a trade surplus calling it a “beggar-your- neighbor” policy. And that is what many countries are doing to us, stimulating their economies by using any means to gain and perpetuate a trade surplus at our expense.

The huge trade deficits are a drag on the economy. The very definition of gross domestic product (GDP) is the sum of the value of all goods and services produced and consumed in the U.S. by consumers, businesses, and government PLUS goods and services exported and MINUS goods and services imported. China’s growth during the past decade and a half is attributable to its GROWING TRADE SURPLUS, its rapid growth of exports and much smaller growth in imports. As our imports increased drastically and exports failed to keep pace, the trade deficits acted as a brake on our economy.

5. Soaring commodity prices, especially oil and its derivatives. Most commodities are traded in world markets using the US dollar as the standard. The price of all commodities, including oil, is quoted in dollars. The astronomic rise in the world price of oil is due to rapidly increasing demand for gasoline and diesel and other uses for oil and its relatively stagnating supply. The U.S., for example, as the world’s largest oil importer of petroleum, has huge resources it does not exploit because of environmentalist pressures. It has chosen to invest in alternative sources of energy which may take decades to develop. It has adopted conservation measures which no one expects to have any significant effect on the problem.

6. The stock market and real estate bubbles. The foreign investment in American stocks and bonds boosted share prices and bond prices and lowered interest rates. Greater risk-taking was encouraged. Amateurs became stock traders and real estate speculators. Wall Street became a huge gambling casino. This contributed to an economically unwarranted boom in stock and real estate prices. The stock market bubble burst in 1999 and the real estate bubble in 2007.

7. Reduced power of the Federal Reserve system to affect interest rates and the money supply. The behavior of prices of goods and securities are controlled more by the foreign purchases of U.S. financial assets trade deficits than the Fed. The dollars earned by foreign countries as a result of our trade deficit, $708 billion in 2007, invested in Treasury obligations and private securities, exert much greater influence on the American economy than Fed actions. As the Asian Tigers can testify, the inflow of huge sums of foreign money caused their bubble (the “Asian Miracle”) in the 1990s which soon became an Asian depression when foreigners tried to repatriate their financial investments. Their central banks were helpless to prevent the economic disaster that befell them. During the past decade, the Fed’s attempt to raise and lower interest rates had little effect on interest rates. The only interest rate the Fed controls is federal funds rate, the rate it charges banks for short-term loans. During much of the last decade, there was an “inversion” during which longer-term government bonds had rates lower than the Fed Funds rate. Normally, the longer the maturity of an obligation, the higher its rate but the purchases of Treasurys by foreign governments kept longer-term rates low.

So what can we do to bring our trade in reasonable balance with the rest of the world. Under the rules of international trade, we can impose barriers to imports from countries with which we have chronic trade deficits. Tariffs may be imposed which would work like a revaluation of their currencies. The advantage of tariffs is that the revenues derived would be substantial. In the afore-mentioned book, we argue for limiting imports to, say, a varying percentage of our exports to them during the previous year, using a device suggested by Warren Buffett, namely, import licenses or certificates. These should not be described as protection. They are not intended to beggar our trading partners, merely to prevent them from beggaring us.

A substantial amount of the deficit consists of imported petroleum and petroleum products, the latter for military and aviation use. They amounted to $330.7 billion in 2007, $50.6 billion in 1998. (What can one say about a country that allows foolish environmental considerations to prevent drilling in the ANWR and on other public lands?!) There are huge subsidies being spent to develop alternative fuels and to use electricity powered hybrid vehicles. No one expects a significant development in less than a decade. In a separate article, we propose gasoline rationing. The demand and supply of petroleum is highly inelastic. A 25 percent reduction in our demand for foreign oil can be expected to result in a fall in the international price of oil of perhaps 20 percent or more. We rationed gasoline during WWII and a rationing plan for emergency implementation is maintained by the U.S. Department of Commerce.

Of course, these are not all of our troubles. These include the federal budget deficit and a tax system that penalize saving and encourages consumption, the high costs of medical insurance and services, an unsatisfactory educational system, a sluggish economy to which the trade deficits contribute, improved public transportation and other infrastructure, etc. Many of these unresolved problems, like the trade deficits themselves, are due to naïve, incompetent, venal, ignorant, and client-serving politicians and non-government organizations (NGO’s) and those who support them. All of which leads to the spending of money by the federal, state, and local governments on things they have no business spending taxpayer money on. Between the environmentalists and the free traders, we are embarked on national suicide.
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Dr. Raymond Richman is Professor Emeritus of Public and International Affairs at the University of Pittsburgh with a PhD in economics from the University of Chicago. With co-authors, Dr. Howard B. Richman and Dr. Jesse T. Richman, he is the author of Ideal Tax Association's recently published book, Trading Away Our Future. How to Fix Our Government-Driven Trade Deficits and Faulty Tax System Before it’s Too Late.

Reported by Raymond L. Richman of Trade-Wars

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