Postcards from Old Europe – Out of Balance
The economic news flow in the last couple of weeks was dominated by the price of oil. Other data releases were mostly relegated to the minor leagues ore duly reported and then ignored.
Take the June trade deficit which was reported at the beginning of August. Jaded watchers of the economy registered that it was worse again and then went on with their business. Andy Warhol would probably have said that any economic indicator can be a star for 15 minutes.
The fact that the trade deficit for June had reached a new record of around $56bn just didn’t grab the market’s attention for long. Was this justified? Some might argue that it was – and is – justified. Aren’t terrorism, the high price of oil and the US election much more pressing concerns than a number from the governments ledger?
Well maybe. The short term is dominated by the issues mentioned above, but I’m convinced that the trade deficit (and the budgetary one as well for that matter) will pose rather large challenges for policy makers in the medium term.
Many people’s knee-jerk reaction to the deficit number was that the $9bn monthly deterioration of the trade balance could surely be ascribed to the higher price of oil. This is not true. The higher price of oil added just around $1.7bn to the import bill. Imports of other goods rose by $3bn – a rather large number but by no means astounding. The real culprit here is the implosion in exports. Exports of goods were weaker across the board with capital goods decreasing the most. The Department of Commerce writes
The May to June change in exports of goods reflected decreases in capital goods ($2.6 billion); industrial supplies and materials ($1.3 billion); foods, feeds, and beverages($0.3 billion); automotive vehicles, parts, and engines ($0.3 billion); and consumer goods ($0.1 billion). An increase occurred in other goods ($0.3 billion).
It is obvious that a further reduction in exports will turbocharge the growth of the deficit if imports do not fall.
The problem is that imports do not at all look as if they are going to do us that favor. The last time imports dropped was during the recession in 2001. It subsequently took them just one year after the recession’s end to power past the previous high reached in 2000. Imports in real terms have been rising at a rate of almost 12% over the past years.
Exports are something different altogether – they were also impacted by the recession and still haven’t reached the level seen in the year 2000. The rate of (real) export growth comes in at somewhere around 9%. To sum it up: imports are growing at a higher rate than exports and imports are much higher in nominal value.
I don’t really want to imagine what will happen to the deficit if exports now start to weaken. Something will have to give and I suspect that that something will be the US currency. The dollar has been weakening vs. the currencies of its major trading partners over the past couple of years. The only problem is that this hasn’t led to a reduction in imports or a higher rate of exports.
One reason that a falling dollar hasn’t impacted imports is that it hasn’t done all that much to import prices. Foreign producers have preferred to take a hit in their profit margins instead of raising prices to counter the effects of a weakening dollar.
The other side of the equation is the fact that foreigners – and especially foreign central banks – have been willing to invest cold hard cash in the US. This capital inflow has taken the pressure off of the US currency over the past months. If the US starts looking like its rate of growth is going to slow, foreigners might find that investing in the US isn’t such a good proposition after all.
Slowing growth might also present the next administration with a logical policy choice: a weak currency. The simple fact of the matter is that imports are still “too cheap” to change consumer’s spending habits while exports are still too expensive to entice foreigners into buying them. I wouldn’t put it past an incoming administration to strong-arm foreign central banks into reducing their pace of currency intervention whilst simultaneously talking down the dollar.
What do you think? Use the comments to your heart’s content and be sure to visit CurryBlog where you can find more of my musings on the markets.