The Trade Deficit rose in June to $53.07 billion from $50.83 billion in May. The rise in the trade deficit is bad news for the economy, and the level is very dangerous.
For the month it was up 4.4%, and it was worse than the $48.0 billion consensus expectation. On a year-over-year basis, the total trade deficit was up 13.2% from $46.89 billion a year ago. The trade balance has two major parts, trade in goods and trade in services. America’s problem is always on the goods side; we actually routinely have a small surplus in services.
Relative to May, the goods deficit rose to $67.58 billion from $65.47 billion. That is a month-to-month increase of 3.2%. Relative to a year ago, the goods deficit was up 14.7% from $58.93 billion. The Service surplus was down slightly from May to $14.51 billion from $14.60 billion. Relative to a year ago it is up 20.3% from $12.06 billion.
Exports Fall, Still on Pace to Double
Exports of goods fell by $4.06 billion, or 3.2%, for the month to $121.21 billion. Relative to a year ago, goods exports are up 15.1%. In other words, we are just above the pace to meet President Obama’s goal of doubling exports of goods over the next five years. On a year-to-date basis, exports are still up 15.8%, above the pace needed to double over five years.
Service exports, on the other hand, were down very slightly for the month (less than 0.1%), and were up 8.0% year over year, which is well short of the pace needed to double over five years (just under 15%). Total exports fell 2.3% for the month but are up 12.9% year over year, right on the pace needed to double over five years.
Doubling exports over five years is all well and good, but not if we also double our imports over the same timeframe. After all, it is net exports which are important to GDP growth, and to employment. The monthly numbers on the import side were somewhat encouraging in this regard, as goods imports fell by $1.91 billion, or 1.0% to $188.79 billion.
…But Imports Also on Pace to Double
Relative to a year ago, goods imports were up by $24.50 billion, or by 14.9%. At that pace, they are also on pace needed more than double over five years. Service imports were up by $50 million on the month or 0.1%. Total imports fell by $1.91 billion or 1.0% for the month to $223.92 billion and are up 13.0% year over year.
Given that imports are starting from a higher base doubling both imports and exports would mean a substantial increase in the size of the trade deficit. Put another way, in June we bought from abroad $1.56 worth of goods for every dollar of goods we sold. That was up from $1.52 in April and equal to a year ago. Including services, we imported $1.31, up from $1.29 in May and equal to a year ago.
Total Trade Deficit Very High & Growing
For all of 2010, the total trade deficit was up an astounding 32.8% to $497.82 billion, with the goods deficit up 27.5% to $646.54 billion, some what offset by the service sector surplus rising 12.0% to $147.82 billion. Trade in goods simply swamps trade in services, even though services are a much larger part of the overall economy.
So far in 2011, the total trade deficit is up 15.2% from the first five months of 2010. The goods deficit is up 17.2%, offset by a 24.3% increase in the service surplus. Year to date, our deficit with the rest of the world is $288.32 billion, up from $250.17 billion in the first half of 2010.
All things being equal, it is better to see trade going up than down. This is not only the second month in a row that the trade deficit has increased, but it is also the second month that it did so due to exports falling faster than imports fell, rather than imports rising faster than exports. We want to see both exports and imports growing, but given the massive deficit we are running, we need to have exports rise dramatically faster than imports, or actually see imports fall.
From a purely nationalistic point of view, rising exports or falling imports are roughly equivalent in terms of economic growth. Falling imports, though, implies economic pain in some other countries. Thus all else being equal, it would be better if most of the improvement in the trade deficit came from rising exports rather than falling imports.
A big part of what made the Great Recession into a global downturn was an absolute collapse in global trade. This can clearly bee seen in the long-term graph of our imports and exports below (from http://www.calculatedriskblog.com/). Falling imports and exports are clearly associated with recessions. In the Great Recession, our imports collapsed faster than our exports, and so we had a very big improvement in the trade deficit.
Falling imports were just about the only thing keeping the economy on life-support during those dark days. That, however, was just a transmission mechanism that spread the recession to the rest of the world. Thus, growing world trade is a good thing, but not if it comes at the expense of an ever-rising U.S. trade deficit.
In other words, all things are not equal. Had it not been for a dramatic improvement in the trade deficit in the fourth quarter of 2010, GDP growth would have been just 0.9%, not 2.9%. In the first quarter of 2011, the change in net exports subtracted 0.34 points to growth, so growth would have been 0.7% rather than 0.4%.
Net exports were a major factor in the shocking revisions to first half GDP growth. In the first look at the second quarter GDP data, net exports added 0.58 points to growth, so we would have been running at just a 0.7% rate without international trade in the second quarter. These bad numbers for June make it likely that when we get the second look at the data, the GDP growth rate is more likely to be revised down than up.
Trade Deficit Far More Serious than Budget Deficit
The trade deficit is a far more serious economic problem, particularly in the short-to-medium term, than is the budget deficit. The trade deficit is directly responsible for the increase in the country’s indebtedness to the rest of the world, not the budget deficit. That is not just a matter of opinion — that is an accounting identity.
Think about it this way: during WWII the federal government ran budget deficits that were FAR larger as a percentage of GDP than we are running today, but we emerged from the war the biggest net creditor to the rest of the world that the world had ever seen up to that point. Then the federal government owed a lot of money, but it owed it to U.S. citizens, not to foreign governments.
Slowly but surely, the trade deficit is now bankrupting the country.
While most of the foreign debt is in T-notes, try think of it as if we were selling-off companies instead of T-notes. This month’s trade deficit is the equivalent of the country selling off Altria (MO), while last month’s deficit was the equivalent of selling off United Health Group (UNH).
How long would it take before every major company in the U.S. was in foreign hands if this keeps up? Put another way, the 2010 trade deficit has totaled $497.82 billion, which is 64% what all the firms in the S&P 500 earned, worldwide, in 2010.
The goods deficit has two major parts — that which is due to our oil addiction, and the Chinese stuff that lines the shelves of Wal-Mart (WMT). Of the total goods deficit of $67.58 billion, $39.61 billion (43.8%) is due to our oil addiction. Relative to the overall trade deficit, our oil addiction is 55.8% of the problem.
For all of 2010, we ran a $265.12 billion deficit just from petroleum. That is equivalent to the more than half combined market capitalizations of all the 208 firms in the Zacks Oil Exploration and Production Industry! That group includes firms like Apache (APA), Anadarko (APC) and Devon (DVN).
The second graph (also from http://www.calculatedriskblog.com/) breaks down the deficit into its oil and non-oil parts over time. It shows that the overall trade deficit (blue line) deteriorated sharply from 1998 to mid-2005 and then remained at just plain awful levels until the financial meltdown caused world trade to come to a screeching halt. That caused a major but unfortunately short lived improvement in the overall deficit.
However, the stabilization in the non-oil deficit started about two years earlier, but that was offset by the effects of soaring oil prices, which caused the oil side of the deficit to deteriorate sharply.
The monthly deterioration in the goods deficit came from the non-oil side, as one would expect given that oil prices sold off after spiking in April. There is a bit of a lag between the oil price futures and the import prices. The average price for the oil we imported in June only fell to $106.00 from May was $108.70 per barrel, which was up from $103.18 in April. A year ago the price was $72.39.
Given the pull back in oil prices, we may get some relief in July, but more of it is likely to show up in August (at least on a month-to-month basis; the year-over-year numbers are still going to look ugly). On the oil side, the deficit dipped to $29.61 billion from $31.59 billion in May (-3.2%), and 38.6% above the $21.36 billion level of a year ago.
The non-oil deficit rose by $3.19 billion or 9.4%. Relative to a year ago, the non-oil deficit was up 0.8% or $280 million.
A Low Dollar Would Help
The best thing that could happen to help on the non-oil side of the trade deficit would be for the dollar to fall (particularly against the Chinese yuan, but against other currencies as well). The decline of the dollar is starting to have a beneficial effect. The strong dollar not only makes imports cheaper, it makes our exports less attractive.
However, a weak dollar will not do anything for the oil side of the deficit. There are few correlations that are stronger in the market over the last few years than oil prices rising when the dollar falls and vice versa. Not quite to the relationship between rising bond yields and falling bond prices, but pretty close.
Competition in Global Trade
U.S. companies are often in direct competition with Japanese or European companies in selling to third countries. For example, both General Electric (GE) and Siemens (SI) make MRI machines for hospitals. Assuming that they were of roughly equal quality, then when the euro rises sharply against the dollar, GE is going to be able to undercut Siemens for export orders to China.
Results by Country
We ran some small trade surpluses with Hong Kong, Singapore and Australia, but we continue to run large deficits with most of our other trading partners. The biggest deficit by far is with China, the source of many of the goods on the shelves of Wal-Mart, Target (TGT) and other big retailers. It rose this month, to $26.7 billion from $25.0 billion in May and $21.6 billion in April. That is 50.3% of our overall trade deficit.
While China has agreed to let the yuan appreciate, so far it has done so at only a glacial pace. However, higher inflation in China than in the U.S. means that the real exchange rate is improving somewhat faster than that.
Our deficit with the European Union rose this month to $9.8 billion, from $8.8 billion. We saw an increase in our trade deficit with OPEC ($13.8 billion vs. $11.3 billion). Our trade deficit with Mexico rose to $6.4 billion from $6.3 billion, while the deficit with Canada (by far our largest trading partner) rose to $2.8 billion from $2.7 billion.
Canada is our single largest foreign oil supplier. The deficit with Japan rose to $4.0 billion from $2.6 billion. That increase might be indicating that the supply chain disruptions from the Tsunami are dissipating. However, it is disappointing that we never moved into a trade surplus with Japan, even with all those disruptions.
Worse Than Expected
Overall, this was a very disappointing report, and worse than expected. Not only did the trade deficit rise, but the decline in both imports and exports shows slowing world trade, indicating a slowing global economy. The non-oil side was particularly discouraging — we really need the dollar to fall further, but the euro is sort of the anti-dollar, and it has problems of its own.
Stepping back a bit, the problem is decidedly not on the export side, at least on a longer-term basis. The last two months are a reason to be concerned. Refer back to the first graph and you will see that the slope of the export line is much steeper than it was in the previous two economic expansions. The problem is on the import side, which is rising at an even faster rate.
It is the change in the trade deficit that drives GDP growth, not the level. As long as the trade deficit shrinks, it will add to overall growth, even if the level is still awful. A rising trade deficit shrinks the economy on just about a dollar-for-dollar basis.
Trade Deficit Should Take Priority
Getting the trade deficit under control has to be one of the top economic priorities. If we do, economic growth will be much higher, and we might actually start to see some significant job creation. With the rise in employment will come higher tax revenues, which will help bring the budget deficit under control.
The Fed seems to understand this, and a weaker dollar is one of the more important mechanisms through which quantitative easing will tend to stimulate the real economy (and is the key reason why we are getting so much criticism about it from the rest of the world, as a decrease in our trade deficit would mean a corresponding decrease in they trade surpluses).
Given very low core inflation and staggering unemployment, I wish that the Fed would embark on QE3, although at this point they might be pushing on a string. Fiscal stimulus would be more helpful, but policy is going strongly in the other direction towards austerity.
The U.S. can simply no longer afford to be the importer of last resort for the rest of the world. As worldwide trade deficits and surpluses have to sum to zero (baring the opening of major trade routes to Alpha Centauri), a reduction in the U.S. trade deficit has to mean that the trade surpluses of other countries has to fall (or other deficit countries have to run even bigger deficits).
Right now every country in the world is trying to maximize exports and minimize imports. We have to fight that battle as well, but it is a fight where we have been getting our butts kicked for decades now. Continuing to lose the fight could result in near fatal damage to our economy and way of life. As I said before, the trade deficit is a far bigger economic problem than the budget deficit, particularly over the short and medium term.
No Signs of Inflation Danger
The downside of a weaker dollar is that it will tend to push up inflation. However, at this point, inflation is not a major problem — particularly core inflation, the non-food and energy part. The final graph shows that core inflation (CPI), which is what the Federal Reserve tends to focus on, is at historic lows. Even including food and energy prices (red line) year over year inflation is still below where it has been for the vast majority of my life.
Those who are running around like chickens with their heads cut off yelling about the “debasement of the currency” are completely off-base. Let’s start worrying about our real problems — we have more than enough of those, rather than imaginary problems. And the trade deficit is high on the list of our real problems. Solving (or even making substantial progress) it would do wonders in helping to resolve the most important problem in the economy right now, the 9.1% unemployment rate.
Seriously folks, look at the graph below, and tell me how anyone could come to the conclusion that right now the Fed should be more concerned about the inflation side of their mandate than they are about the full employment side. How can you take opinions like that seriously?
APACHE CORP (APA): Free Stock Analysis Report
ANADARKO PETROL (APC): Free Stock Analysis Report
DEVON ENERGY (DVN): Free Stock Analysis Report
ALTRIA GROUP (MO): Free Stock Analysis Report
UNITEDHEALTH GP (UNH): Free Stock Analysis Report
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