Is trade deficit stabilization at hand?
by: Menzie Chinn
September’s trade balance figures were released by BEA yesterday. The $66.1 billion figure was larger than the consensus $61.5.
Bloomberg’s assessment
was fairly upbeat:
The trade gap in goods and services followed a revised $59.3 billion deficit in August, the Commerce Department said today in Washington. Imports rose 2.4 percent and exports slumped 2.6 percent, the biggest decline since September 2001. The monthly trade deficit with China rose to a record $20.1 billion.
The nation imported a record $23.8 billion worth of petroleum as prices jumped after Hurricanes Katrina and Rita disrupted production on the Gulf Coast. A strike at Boeing Co. contributed to a 72 percent drop in aircraft exports. Oil prices have since receded, the Boeing strike was settled, and foreign economies are accelerating, suggesting exports may rebound and the trade deficit won’t widen much more, economists said.
The jump in the deficit “should be seen as a temporary move rather than a general trend at this point,” Peter Kretzmer, a senior economist at Banc of America Securities Inc. in New York, said before the report. “The trend appears to be a gradual improvement in the trade deficit or at least a stabilization.”
Given that some of these temporary factors could have been anticipated, I have to wonder why the consensus figure didn’t already reflect these
effects.
Looking at the graph of the trade balance and the trade balance ex-oil series provides, it’s a little difficult to discern the
stabilization that’s alluded to, although it might be the ex-oil series that’s being mentioned. And while prices have receded (BLS also released October
import and export prices yesterday), the October decline of 0.3% import prices followed a 2.3% increase in September.
Similarly, the October decline of 4.4% in petroleum imports did not fully offset the 8% increase in September. Since futures for oil up to March 2006
delivery do not show substantial decline, and futures indicate continued high prices for natural gas through the winter months (15% of consumption is imported), I don’t see a stabilization in the dollar value of the total trade deficit.
Brad Setser seems to share my skepticism. Looking at goods alone, it is also hard to see the purported stabilization. The actual and three month moving average of the goods trade balance are shown in the figure below:
Nice post! I agree, there’s no trade stabilization. I would like to know if you think that the trade deficit can stabilize without a change in the US economic policy.
Eugenio: The trade balance could, in principle, stabilize as a share of GDP if rest of world growth accelerates a lot. It also depends what you think will happen if even if U.S. fiscal and monetary policy continues on in the way it has. If there is a big collapse in the housing market that drastically reduces equity withdrawal, consumption and hence US imports could fall substantially.
One important fact to keep in mind is that even if the trade balance stabilizes at, say, 6.5% of GDP, this implies ever increasing indebtedness to the rest-of-the-world. This is why I believe stabilization of the deficit — even if it’s on the horizon, which is questionable — is not sufficient to guarantee a sustainable path for the current account and economic growth.
Menzie
There are a few items that might have additional moderating affect.
Given the time lag, I would expect auto imports in September & October only minimally reflect the slow down in vehicle sales. If softness continues in this sector, it will take some time for the auto dealers to work off their inventory.
Recovery of Gulf of Mexico production, and declining prices for petroleum should provide some favorable numbers on a month to month basis, but we will still have negatives versus a year ago.
The relative strength of the dollar should provide some short term relief, but we all share the common concern that continued trade deficits must at some time take their toll on the value of the buck.
Always be careful with the term stable. Dead is a stable condition.
Bill
Bill-
If you look at the value of the buck on a trade-weighted basis things don’t look all that bad. The major trading partners of the U.S.,last time I looked,were Canada,Mexico,and Japan. The dollar is doing ok vs. those currencies.
I’m one of those people who don’t believe the trade deficits affect the dollar’s value,rather the other way around. I’m a believer in the purchasing power parity theory of exchange rates. Go to the border crossing at McCallen Texas and see which way the merchandise is moving. That’ll tell you whether the dollar is over- or under-valued,at leat vs. the Mexican peso. When the dollar is cheap Mexicans shop in the U.S. That affects the U.S. trade balance and depends on the relative price levels between the two countries.
You say that the relative strength of the dollar should provide some short-term relief. It really depends on price elasticity and the terms of trade,but I would argue just the opposite. A stronger dollar encourages imports,discourages exports. If the dollar remains stronger over a long period of time then sellers can adjust prices, build new plants,etc. But that takes time.
Trade balance consists mainly of consuming by US people in it’s imports part (including gas, clothes and so on) and exports of capital goods for developing and manufacturing technology-hungry countries.
The first will stay stable as long as americans consume (by extracting value from RE or something else, that you can mention).
The latter will save dificit from further swelling until there are no jet-liner’s plants, big research-labs and high-tech chemical factories in the rest of non-Europe world.
Nice post and topic-
It would be nice to know more precisely what products and countries drive the deficit.
Katrina may have disrupted exports (e.g, agriculture grains) from the Port of New Orleans. I am not sure.
Interestingly, in real terms POL imports were down sharply last month even though nominal imports soared. Moreover, the sharp slowndown in the growth of real non-petroleum imports that has developed over the last few months is still in place.
another idea
retailers such as Wal Mart under tons of pressure to increase same store sales. Retail is very competitive (Target, Wal Mart, etc). I have heard merchandising is getting very sophisticated, aggressive and urgent at retailers this year. Professor DeLong blogged about how many mail order catalog he gets. maybe this drives some of the deficit?
I should mention that there has been substantial commentary since I wrote this post.
DeLong at http://delong.typepad.com/sdj/2005/11/creeping_closer.html
Altig at http://macroblog.typepad.com/macroblog/2005/11/china_fixation.html
One issue that has come up is the relationship between the dollar, relative prices and the trade balance. It always bears repeating that all three of these variables are jointly determined in a bigger system of equations that encompasses capital inflows, GDP at home and abroad, expectations about asset returns over time, etc. That being said, some things matter more at certain horizons than at other — and as long as purchasing power parity (as mentioned by Jim Miller) does not hold in the short run, then movements in the nominal value of the dollar do affect the terms of trade and the real exchange rate. What moves the dollar over the longer term? Certainly prices, but I’d say more variation is accounted for by capital flows.
So when I mention the dollar affecting the trade balance, I’m focusing on the short horizon. At the longer horizon, the trade balance (the main component of the current account) must be influence by prices, and the net international investment position (as I discussed in my earlier post on the twin deficits).
It is at this short horizon that the components of the trade flows matter for aggregate flows. In response to two queries — the biggest U.S. exports by end-use categories are capital goods and industrial supplies ($266 and $174 bn Jan-Sep this year), while the biggest U.S. imports are consumer goods and industrial goods ($374 and $305 billion), with capital goods a close third ($263 billion). News reports correctly point out a big drop in civilian aircraft exports ($2.4 billion) accounts for a chunk of the deterioration in the trade deficit. However, my question is whether this accounts for the “news” in terms of the deviation of ex post realization of $66.1 billion relative to the Bloomberg survey consensus (ex ante) prediction of $61.5 billion. First, $2.4 billion is not $4.6 billion. Second, didn’t these economists look at the aircraft delivery numbers? After all, there aren’t that many U.S. civilian aircraft manufacturers. (On the other hand, aircraft exports is a volatile figure — I’ll try to figure this one out).
Finally, let me return to the countervailing short term impact of the dollar’s movements on the trade deficit. It appears the consensus view is that interest rates trends will drive the dollar upward in value over the next few months. This means that the dollar value of imports will decrease as it takes fewer dollars to buy a single unit of foreign currency. On the other hand, the quantity of imports will tend to increase, and of imports decrease, due to the cheapening of foreign goods relative to American goods. Followers of the macro-trade literature will recognize this as the reverse of the standard “J-curve” effect. This means we are making the eventual adjustment process more difficult in the longer term because we are encouraging more imports. So, in some sense, the true extent of the deficit is being masked by the dollar’s appreciation this year.
Nate: The consensus view seems to be that agricultural exports were not very disrupted by the effect of Hurrican Katrina on New Orleans. This makes the deterioration in the trade deficit more worrisome, in that it does not appear to be driven by a one-shot event.
Spencer: Not certain what POL imports are. But I find that nominal non-oil imports increased by 2.3% m-o-m non-annualized terms in September, vs. 0.9% in August. Do you mean the growth is decelerating?
http://news.morningstar.com/news/MW/M11/D03/AAC32AFC-8BC7-46EA-B411-31632FECAE59.html
october retail sales surprised a lot of people on the upside. this may figure into the trade deficit numbers (retail sales might have been imported consumer goods?)
wal mart did better than i expected recently. one explanation i saw or heard (can not remember where at this point) in the news was early cold weather and consumer purchase of coats and stuff.
http://money.cnn.com/2005/11/10/markets/bondcenter/bonds/index.htm
what is your perspective on the demand for the 10-year treasury?
i read the macroblog URL. It said China’s exports were fueled by electronics (electrical appliances and electronic products).
what is in electronics?
does Haier product show up in these numbers?
what is the lead time on U.S. imports of China’s exports? [How long time-wise does it take from the point of the U.S. initiating an order to the U.S. receiving the goods? (and the goods showing up in deficits)?]
Nate: Some tough questions there.
Retail sales and imports.
Surely some of September’s imports made it into the recent retails sales figures. But I have no idea how fast goods pass through Customs to the store.
Freight times. How long it takes for freight to get from China to the US? About four to six weeks, according to this article (which discusses the tradeoffs more generally).
http://bigpicture.typepad.com/.shared/image.html?/photos/uncategorized/20051111.gif
Haier goods. If the Haier goods are manufactured in China, then they should show up in these numbers.
One Caveat: It is misleading to construe all imports from China as constituting Chinese value-added. That is because China imports a large amount of components to be used in producing exports. That is partly why most assessments of a Chinese devaluation do not conclude that there will be a large effect on the Chinese trade balance from changes in the Renminbi/dollar exchange rate.
Mistake in the previous post. The correct URL for the article is as follows:
http://www.strategy-business.com/resiliencereport/resilience/rr00015?pg=all
(Although the graphic from the Big Picture is also illuminating).
check out the article on the cover of strategy-business.com and then see the retail at the URL below (all new retail since 1997)
http://www.theshoppesatgrandprairie.com/
Menzie,
Thanks for the post. Got a question for ya. You say:
“If there is a big collapse in the housing market that drastically reduces equity withdrawal, consumption and hence US imports could fall substantially.”
Is this necessarily so if housing equity drops over the next five years, as i believe it will? If, say in the electronics sector, American goods are more expensive than their Chinese counterparts, wouldn’t Chinese goods become increasingly attractive in a slowdown?
Skoobz: Good question. As perceived wealth in housing declines, then consumption should decline. At the same time, there may be sustitution toward more inexpensive Chinese electronics away from more expensive ones — although I’d be hard pressed to think of major producers of consumer electronics that still produce in the U.S. But a decline in domestic consumption would probably be accompanied by reduced value of the dollar (against a broad basket of currencies), thereby reducing imports of goods produced overall.
The focus on overall import prices highlights the fact that China per se is not the issue — rather it is value of the dollar overall with our trading partners. Chinese revaluation will spur the revaluation of other East Asian currencies, thus moving forward the process of adjustment.
Menzie, you said:
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The focus on overall import prices highlights the fact that China per se is not the issue — rather it is value of the dollar overall with our trading partners. Chinese revaluation will spur the revaluation of other East Asian currencies, thus moving forward the process of adjustment.
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I differ.
I insist that if you have one guy (the Chinese) with the capability of producing the same goods, –but with significant lower costs (at the point of purchase) … due mainly to much lower wages, it will have the effect of a black hole in lowering worldwide wages!
Changes in rates of exchange and import tariffs are not solutions, but the road we will travel (most likely) in order to achieve some sort of wage equilibrium…this is the crux issue.
If we stay put, or we move in the wrong direction, -such as appreciating the US dollar, Chinese low wages will continue to eat away investment, employment and market share from the west; otherwise called deflation.
If we move along changes to the exchange rates (a rise of the Yuan/US dollar exchange) or tariffs, lowering of western wages will arrive through inflation or a loss in worker’s buying power.
IMO, the easiest road is to have the Fed devalue the US dollar –they control the supply of USD; but one should stress that this road too is also quite painful to travel.
I have nothing against the Chinese, to the contrary I have great admiration for them. If one looks at the world, their economy has taken out of abject poverty over 350 million workers …quite an achievement!
If they’re willing to work for lower wages
…we, the west, have to meet them
…and the sooner, the better
…If not, the west loses investment opportunities, suffers irreparable erosion to its manufacturing capacity and market share.
…Why give all of this away, if we will all get to (some sort of) wage equilibrium anyhow?
here is an idea:
what about increasing the savings rate slightly in the U.S. with the offset being a slight decrease in consumption growth? what are current U.S. govt incentives for people to save vs. consume?
Joe Rotger: As long as countries are defined by limited factor mobility across borders (and labor remains largely immobile in this respect), then comparative advantage is the critical factor, and an economy always has a comparative advantage in something. Hence, low wages due to relative abundance in low skilled labor in China give it an advantage in exporting low-technology goods. The U.S. will always export something.
I refer you to Paul Krugman’s old, but still very relevant article, “Competitiveness: A Dangerous Obsession,” in Foreign Affairs (1994).
http://www.foreignaffairs.org/19940301faessay5094/paul-krugman/competitiveness-a-dangerous-obsession.html
For an assessment of China specifically, see, Kamin et al., “Is China Exporting Deflation?”,
http://www.federalreserve.gov/pubs/ifdp/2004/791/ifdp791.pdf
Nate: When observors bemoans the low savings rate, they are usually focusing on the household savings rate, which is indeed very near zero. However, it is important to stress that private sector savings (i.e., including corporate savings) are not altogether that low (while Federal government savings are very low). We unfortunately do not know how to spur household savings. See Eric M. Engen, William G. Gale, and John Karl Scholz, “The Illusory Effects of Saving Incentives on Saving,” Journal of Economic Perspectives 10, No. 4 (1996), pp. 113?38.
That is why I stress the importance of increasing public sector savings. That we know how to do: cut spending and raise tax revenues.
Menzie,
Chinese are not exporting only low tech goods…Dell parts, Sony, IBM PCs …you name it.
…Taiwanese are pretty much involved in China, so are the Japanese, Europeans …and US companies, for that matter …it’s a matter of survival for most companies in the world!
…Know how and investment is brought in droves into China because of low Chinese wages, and of course lured by the potential of the Chinese market.
Delphi is belly up …GM is following short behind…
Yes, the US government should rein in their expenses …although I fear this may add salt to the wounded American economy …no use crying over spilled milk, either.
But, if we cannot compete out there …and a higher USD ain’t helping … and we keep on losing market share around the world –
…US exports to Europe were down …Chinese exports to Europe were up … which shouldn’t surprise anyone … I don’t see how we’re going to ever balance the trade deficit …mind you, the interest on the debt repayment is going to chew our socks away…
Well, the public sector …gets its revenue from taxing companies in the US, if they sell less, their profits and contribution to the public sector revenue become nada, or close to it …isn’t this the main reason why the government’s savings are negative? …tax collection went down and expenses went up?
I do understand that saving more is the right thing to do …but, the point I’m trying to make, is that this effort (with an unlikely success) will not be enough…
…the US has an appaling competitor that moved into the neighborhood …and we need to do something effective about it … let the US dollar take its natural course …down!
BTW, thanks for the advice on what to read.
Menzie,
In regards to Krugman…
You’ve already answered the issue of competitiveness yourself …I would love to live in Shanghai, they tell me it’s quite an interesting place …but, I would have a little trouble moving the wife over there …labor mobility is the issue.
Listen, I think what we’re seeing worldwide is quite nice, the Chinese with their effort have done a great task for humanity’s benefit, they’ve brought welfare to 100s of million of Chinese …humanity as a whole is doing much better.
…Paretto’s theorem, the optimum of the whole is better than the sum of the optimums of the parts …you know, the precursor stuff for “The Beatiful Mind”.
So, my concern is with the American and western worker, and how to minimize his pain, because I insist, his wages are coming dooooown!
In regards to Kamin et al,
I still got a whole lot of reading to do…
But, the little I read, I don’t like.
First, they sustain that the Chinese influence on the US economy is reduced to measuring the extent US prices are lowered.
I disagree, where did they get this idea?
Investment is moving to China because it’s more profitable to do so! The ROI is better …and this is due to lower wages, which allow greater profit margins.
The price of a good could be the same, manufactured in China or the US, but, if the profits from the made in China good are larger, eventually the larger fish will eat the little fishy…
Does Nike sell their shoes for less because their made in China? …I don’t think so…
I would say that a Chinese company’s optimum price level lies in a range which is very close to the existing price, undercutting it just a little (I’m guessing 3-5 %), enough to make inroads into his US counterpart’s market share.
I’m sure there are 20+ price schemes depending on the goods involved…
Then there is the component price issue, or the price of the part used in the final product, i.e. Delphi parts used in GM vehicles. Evidently, the CPI may not be affected, although we’ve seen cars definitely come down in price.
Is the BLS taking into account the millions of parts that make up machinery, x10 for the different and x10 for older models? …I don’t think so…
The more I think about prices, the more confusing I see it is to determine their true price within a (10%) range. How do these guys at the BLS approach the pricing issues?
* Sales, trade-ins, 0% interest pay nothing for a year…
I’m sure it’s comparing apples to apples…
Which brings me to another issue, somehow I visualize aggregation of prices is at the least dubious for this kind of study, to try to compare CPIs, PPIs… Intuitively, I think it’s not good to mix the voids (Mercedes ans Cartier are doing fine, thankyou) with the head-on competition collisions…
I’ll come back when I’ve read some more…
Joe Rotger: In defense of Kamin et al. — the impact of China was, back then, widely construed to take the form of price effects. Nobody doubted that the size of trade flows from China had increased — but it was unclear how much that was substituting for trade flows from the other East Asian economies. Hence, the focus on relative prices (which, in the standard factor proportions model, aka Hecksher-Ohlin) leads to changes in relative factor prices (wages, return on capital). If there is no big impact on prices, then it is unlikely — although not impossible — there are large impacts on factor prices.
If we think that China does have an impact, once again, it doesn’t drag down all wages. Rather it tends to drive down wages in those sectors that Chinese industry has a comparative advantage in. In fact the model predicts that wages will rise in those sectors the US has a comparative advantage (and it’s not in assembling desktop PCs, it’s in designing chips and writing sofware, etc.)
This should not be taken to imply that we have nothing to worry about — rather that we should worry about the right things. In this case, the implications are for trade-related job dislocation and widening wage inequality. For a graphical depiction, see:
http://www.ssc.wisc.edu/~mchinn/inequality_in_HO.pdf
The proper response to this effect are a combination of appropriate macro policies (cut the budget deficit, manage dollar depreciation) and micro policies (enhanced trade adjustment assistance).
Can anyone explain to me why a trade deficit between the US and China matters but a trade deficit between New York and California does not?
kp: New York and California share a common money, and have factor (capital and labor) mobility between them. They also exist within a common fiscal authority (the US government). None of these hold true for the US and China.