The Hindu Business Line : The curious rise of US trade deficit

After the massive devaluation of the dollar, the US trade deficit position seems to have become worse than what it was in the beginning before the dollar began its slide. The trade deficit, incidentally has consistently accounted for some 92 per cent of the total current account deficit of the US.

DESPITE the large fall in the value of the dollar, the US trade deficit keeps going up. According to the latest figures from the US Department of Commerce, the deficit over the period January to March 2005, at $174 billion, was 25.4 per cent higher than the deficit for the corresponding period last year. Should this trend continue through the rest of this year, the trade deficit will touch $774 billion against $617 billion in 2004 and a mere $497 billion in 2003. In short, at the end of the day, after the massive devaluation of the dollar, the position seems likely to be worse than it was in the beginning, before the dollar began its slide. The trade deficit, incidentally has consistently accounted for some 92 per cent of the total current account deficit of the US.

The US Treasury Secretary, Mr John Snow, recently told CNBC television in an interview that "it is time for China to revalue, and it should revalue sooner than later". Driven by the same logic, US lawmakers have voted to impose an across the board 27.5 per cent tariff on imports from China if China does not revalue.

Morgan Stanley analyst Andy Xie, in a note to his clients, dismissed this as an `empty threat', given the number of US businesses and jobs which relied on adding value to Chinese imports. That China does not view the matter quite so lightly is clear from the sharp 20 per cent drop in its textile and apparel exports to the US in March 2005 over the level achieved in February. Nevertheless, the fact remains that fears of Chinese imports sending the US trade deficit plummeting are quite unfounded.

On October 30, 2003, Dr. N. Gregory Mankiw, Chairman of the Council of Economic Advisers to President Bush, testified before the House Committee on Ways and Means that trade with the world "and with China in particular" provided substantial benefits to the US economy. The rapid growth in China's trade since the mid-1990s, and the spurt which followed since 2000, had been "fairly evenly divided between growth in China's exports and its imports". Chinese imports of goods amounted to roughly one quarter of its GDP, well above the share for the US and Japan, for which the comparable ratio stood at around 10 per cent. Chinese imports of both manufactured goods and raw materials had more than doubled over the past seven years. In fact, China had had a trade deficit with the world excluding the US for several years. The US trade deficit with China in goods was large and had more than doubled between 1995 and 2000 to around $125 billion a year. However, it was important to put this deficit with China into context.

At the same time that the US deficit with China increased, the overall US trade deficit with all countries other than China also rose sharply. In fact, China's contribution to the total deficit had actually fallen in recent years. In 2003, China contributed to the overall trade deficit, in proportionate terms, no more than it did in 1993, before the spurt in its two-way trade with the US and the rest of the world. Besides there was evidence that imports from China displaced imports from other countries, with better and lower priced goods, and were as such definitely a good thing for the US economy. Furthermore, declining exports, not rising imports, accounted for the recent increases in the US trade deficit.

Over the past three years, US manufacturing exports had fallen by about 10 per cent while imports had remained flat. Without China, the export growth would have been even slower. Although the US exports to the world, excluding China, had fallen since 2000, US exports to China grew rapidly over the same period. China was the seventh largest export market for the US, ranking after South Korea, but ahead of France.

The political sentiments and economic arguments in Mr Mankiw's testimony were repeated almost verbatim in Mr George Bush's Economic Report of the President last year. This document, however, also went on to address the question: If China was not responsible, who or what was?

The gist of the President's position on the who-dun-it-if-not-China part of the story was that it was large inflows on the capital account that financed current account deficits and made them possible. This position was recently elaborated in the course of a speech by the US Federal Reserve Governor, Mr Ben S. Bernanke, on April 14.

Capital inflows, he said, were not only financing the large and growing current deficit, which had touched 5.75 per cent of GDP, but were also compensating for the large outflows of capital from the US; $818 billion in 2004.

While in the mid-1990s these flows were mainly on the private account, sucked into the US by a buoyant stock market, these had been replaced by official inflows since the beginning of the century, particularly from Japan, China, South Korea, Taiwan and India.

According to figures posted online by the Bureau of Economic Analysis of the US Department of Commerce, Asian countries, with holdings of $1.348 trillion, accounted for 72.8 per cent of total foreign official assets in the US as of December 31, 2004. That is more than 10 per cent of the US GDP for that year, a little over $11 trillion. European countries were a distant second, with aggregate official foreign holdings of $347.675 billion.

In his Economic Report, Mr Bush made three other comments which are worth taking on board in conclusion. First, there was no reason to suppose that the huge budget deficits being run by his government had played any part in aggravating the problem of external deficit; the latter had been both large and rapidly growing even when the budget was running a huge surplus — before he took office, though the President, of course, did not dwell too much on this point. Second, focusing on the problem of the external deficit required a focus on net capital inflows, rather than any other factor(s).

Lastly, what mattered was not how much money was flowing into the economy — what the US was in effect borrowing from the rest of the world — but rather what became of it. If, for example, inflows were being used to boost investment and therefore growth they were clearly a good thing, and were to be welcomed as such. On the other hand, if debt was being used to finance an "extravagant vacation" that was clearly something to worry about.

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