US slumps, trade deficit doesn’t shrink …
The reasons why the US slowdown — led by a fall in investment — didn't lead to an improvement in the trade balance in the first quarter aren't that hard to find.
Consumption growth was actually very strong — nearly as strong as in 2004 (see p. 5) . That was a year when the trade deficit really widened. Strong consumption growth pulled in imports — especially, I suspect, Asian imports. Canada exports lots of wood and autos, and neither housing or the US automobile sector is doing well right now. And European exports to the US face the a large currency headwind.
But what of exports? Shouldn't a booming global economy — and weakish dollar — help boost US exports? In theory, yes. But that didn't happen in the first quarter. The BEA estimates exports fell a bit in q1 (v. q4). And looking at the US export data, I can see why. The y/y rate of export growth has slowed — and the q/q growth rate (using a rolling three month sum that takes December-February as the last quarter) has been decelerating sharply for the past couple of months.
What happened? To be honest, I don't know. Part of it is that export growth was very strong in q4, and net exports contributed very strongly to growth in q4 (see p. 6). That set a high base.
Part of it is that the dollar isn't really all that weak. It is very weak — it hit a record low v the euro today — against all European currencies. And it is weak against the commodity-exporting, high carry, high current account deficit countries in the South Pacific. But it isn't weak against the yen, against the RMB or against many other emerging currencies. The story right now is generalized euro strength, not generalized dollar weakness.
That matters. Net exports didn't contribute positively to US growth in the first quarter. But they contributed very positively to China's growth in the first quarter. The US needed a boost. China didn't. So long as dollar weakness (against europe and some others) means RMB weakness (against europe and some others) it may do more to boost the Chinese economy than the US economy.
Globally, a fall in the commodity exporters' surplus will be offset by a rise in Asia's surplus, not a fall in the US deficit. That clearly is what happened in q1.
Since private capital wants to flow into Asia, not flow out of it, the rise in Asia's surplus also means that Asian central banks — with a bit of help from Latam and Russia — had to finance a growing share of the US deficit. That also clearly happened in q1.
A fall in investment usually generates an improvement in the current account deficit. That didn't happen in the US, at least not in q1. Savings — by definition — fell faster than investment. Presumably US households drew on their savings to support ongoing strong consumption growth.
A guess that shouldn't be a total surprise. A surge in investment usually leads to a deterioration in the current account balance. That happened in the US in the late 90s — and again from 2003-05, when residential investment surged. But the huge surge in investment in China has been associated with a growing external surplus. Savings has increased more.
My interpretation of all this? No shock. The de facto US-Chinese currency and monetary union has introduced a lot of distortions into the global economy. It is a strange monetary union. The faster growing portion of the monetary union has lower interest rates than the slower growing portion of the monetary union (because of expectations of RMB appreciation). And it has led the real exchange rate of the industrialized economy with the largest current account surplus to depreciate even as its economy booms …
It would be interesting to follow the effects of dollar depreciation vs Euro on US-EU trade flows right now, to see the time-shape of the J curve. Any clue?
Well, the US bilateral deficit with the Eurozone has started to improve over the past few months, which would suggest that competitiveness is trumping price effects for the time being…
Thanks MM. Any detail or graph welcome!
http://bp2.blogger.com/_eKH-tiSXFbc/Rf_SLlnPNHI/AAAAAAAAAeg/f8zY6qO6gh8/s1600-h/trade+amount.JPG
You can just about see it there. Eurozone is the blue line labelled 1. All I can muster as I walk out the door…
Brad,
Compared with Japan, China is far more responsible with its monetary policies, but since Japan is considered a “strategic ally” of the US, the multi-trillion dollar “yen carry trade” is ignored in Washington. It appears the Japanese are willing to risk a destruction of their currency to continue to export to American consumers. In contrast, the Chinese are taking their imbalances very seriously and are working hard at addressing many economic issues facing a nation governing a 1.3 billion population. As Gheorghius previously writes, the Chinese yuan has been decoupled from the US dollar peg, but it retains a large Japan yen component in its weighted basket. The Bush Administration appears to welcome financing of its massive US budget deficits by Wall Street Hedge Fund Carry traders. But until Treasury Secretary Paulson is willing to address the US double standard in its trade relations with China and Japan, expect little further cooperation from the Chinese in resolving global economic imbalances. Of course, there is also an unconventional solution to resolving US economic imbalances: live within your means and do not issue government debt.
Hmmm…real deposit rates and long term government yields are substantially higher in Japan than in China. Japan is a 2% nominal growth economy; China is a 15% nominal growth economy. Japan hasn’t intervened in 3 years; it’s been about 3 hours since China was last seen in the foreign exchange market. Who’s running the responsible monetary policy again?
And Dave- if you want to talk to the biggest perpetrator of the yen carry trade- give your mates at SAFE a call. $1.2 trillion in reserves, and they appear in the market buying USD/JPY.
(1) The story right now is generalized euro strength, not generalized dollar weakness.
Sad but true. Still, the $ is quite weak on a trade-weighted basis as well.
(2) What happened? To be honest, I don’t know.
Same here. What is notable to me at least is that imports (-0.37%) were a bigger drag on % change in real GDP than exports (-0.14%). Would anyone know what the seasonal adjustment factor is? That might help.
Macroman,
It is a blatantly falsehood to accuse the PBoC in the “carry trade” from the US dollar into the Japan yen. The vast majority of PBoC dollar reserves are parked in US Treasurys and US government backed mortgage securities. And if the US government is so concerned about Chinese ownership of US bonds, why not just live within the budget and stop selling government debt securities. It’s really so simple.
But even the PBoC holdings are a small firecracker compared with Hedge Fund holdings of derivative contracts. Combined turnover measured in notional amounts of interest rate, equity index and currency contracts increased to $429 trillion between January and March 2006. The combined notional value of all contracts comes to almost $800 trillion. Hedge Funds are the real Currency Manipulators in foreign exchange (FX) contracts.
Dave, do you really not understand the difference between gross turnover and net positioning? Seriously? Correct me if I am wrong, but I am assuming that the next interbank foreign exchange transaction that you conduct will be your first. How exactly does that qualify you to tell me or anyone else who is manipulating exchange rates, other than via your (admittedly vivid) imagination for conspiracy theories?
MM thanks for the graph but (there’s no denomination on the colored lines) we need to distinguish at least imports from exports. As u know, if imports fall that may be the income effect of a growth slowdown, nothing to do with prices, competitiveness and Jcurve.
I think that this polite blog by brad is the very best,
And it’s very nice to have D. Ch., MM and Gheorghius arguing politely in the same place, thanks to you brad and your fine style.
Anyway, way off of the subject…, I’d like to bring some little discussion about real economy and financials, dow hights and inflation, to invite MM and everybody else to make some comments about this article by Peter Schiff’s:
“As the Dow burst through the 13,000 milestone this week, few understood the hollowness of the achievement. Measured against the rising dollar-denominated prices of just about everything else on the planet, the Dow has actually lost value over the past seven years. Measured against the truest benchmark, the price of gold, the record high for the Dow was set back in January of 2000 when its price equaled approximately 43 ounces of gold. Today it is only worth about 19 ounces.
To better appreciate just how much of stock gains can be attributed to inflation, consider that the record high for the Dow in 1929 of approximately 380 also equated to 19 ounces of gold. So despite all of the hoopla and a thirty-fold increase in stock prices, the Dow has actually gained no real value during the past eighty years. The entire rise from 360 to 13,000 has been an illusion made possible by the magic of inflation. So much for the concept of stocks being a “can’t lose” long term investment — unless you feel that eighty years is not quite a long enough time horizon!
Now that is not to imply that the Dow has not generated returns during those years: it has. However, those returns have been a function of dividends and not appreciation. But its not yields that Wall Street celebrates, its prices. By dazzling investors with higher prices, they distract their attention from the unpleasant reality that they are actually treading water. What difference does it make if you have more dollars if the dollars themselves have less purchasing power?
Despite its recent eclipse of 13,000 the Dow now buys 30% fewer euros than it did then back in 2000 when it was priced at approximately 11,500. It also buys 35% fewer gallons of milk, 40% fewer bushels of corn or wheat, 65% fewer ounces of silver, 70% fewer barrels of oil, 80% fewer pounds of copper, and 90% fewer pounds of uranium. Try figuring what the Dow will buy in terms of other necessities, such as housing, insurance, college tuition or hospitalization. Any way you measure it, the Dow is worth far less today then it was in January of 2000.
Back in 1980 one Zimbabwe dollar was worth more than one U.S. dollar. Therefore a billionaire in Zimbabwe was also a billionaire in America. Today, almost everyone in Zimbabwe is a billionaire yet few of them can afford a pack of chewing gum. Do you think that anyone invested in the Zimbabwean stock market these past 30 years cares how many record highs that market has made?
Many might feel that a comparison of the U.S. to Zimbabwe is ridiculous. However, fundamentally there is no real difference between a Zimbabwean dollar and an American dollar. They are both simply pieces of paper, the value of which depends on the resolve of politicians not to print too many of them. During the difficult economic times that lie ahead, the pressure on the Fed to run its printing presses full throttle will be immense.
Think back to the German experience with hyper-inflation during the Weimar Republic. At the time of its currency meltdown, Germany was a major economic power (even after the devastation of the First World War). Yet that status did not prevent its currency from becoming worthless. The impetus for Germany’s hyper-inflation was the fact that its industrial base had been badly damaged during the war, yet under the terms of Treaty of Versailles it was obligated to pay enormous reparations to the Allies. Lacking the ability to export enough goods to repay its debts, it resorted to a printing press instead. America is now in a similar predicament. Although our industry was not destroyed by bombs, it’s gone just the same. While we might not be bound by a treaty to pay reparations, the trillions of dollars of American IOU’s now owned by foreigners will be just as burdensome an obligation. It is hard to image we can “repay” these debts without civil unrest, massive inflation, or both.
The point to remember is that when it comes to records, it is real purchasing power, not nominal value, that counts. Measured by its purchasing power, the Dow has clearly lost value over the past seven years. Those who have remained invested in Dow stocks during that time period are clearly poorer as a result. Those who continue doing so will likely lose even more wealth in the years ahead, regardless of how many more nominal record highs the Dow sets.”
I’d appreciate some comments in this ex-cursus…
Best wishes top you all
koteli
http://www.businessweek.com/magazine/content/07_19/b4033062.htm - “…it looks as if the U.S. is well on the way to depreciating its way out of its trade deficit without disaster. U.S. inflation hasn’t heated up, and the Federal Reserve hasn’t had to raise rates to defend the currency. “It sells better to say we’re up for some catastrophic explosion” in currency markets, says Menzie Chinn…”
Interesting article at http://www.stlouisfed.org by William Poole
Re Peter Schiff article:
Anybody who conveniently dismisses the importance of dividends from measures of long run stock market returns is either a dissembler or a fool. It’s most of it. Given that gold pays no dividends, and using the author’s own numbers, it only shows what a rotten investment gold has been since 1929.
It would be more interesting to know what the real value of the stock market is in relation to its long run average. It may be less extreme than in 2000, but stocks, and many more risky assets, still seem expensive to me, and I would ask whether the relationship between asset prices and other prices can return to “normal” without problems.
It surprises me that the conspiracy theorists do not make much of the fact that the US is by far the largest holder of gold.
As far as gold is concerned, the gold price of the Dow is about as useful an economic indicator as the Dow price of gold. Why not focus on the uranium price of the Dow? Gold, useful for jewelry, is an antiquated measure of monetary value. As a measure of inflation, it is about as concentrated and biased as one might get. The predictions of the central bank conspiracy theorists are for a Dow gold price of something closer to 5 ounces. One should factor the corresponding probability into portfolio decisions and drive on. The float for bullion and gold equities is ridiculously less than that for the rest of the investment universe.
The point on the gold and Euro prices of the Dow is obvious. But why cherry pick assets in the exercise? One could capitalize personal consumption expenditures as a liability, using a gold or Euro price, and find that the gold or Euro cost of U.S. living has declined relative to the gold or Euro cost of Euro living - including housing. Cash in your gold and Euro Dow now and live high!
Well, the wife killed a long write up I did, so I’ll summarize the points. Guest at 8:41 has hit the crux of the issue; dividends, compounded over time, greatly magnify the returns on equities.
At the end of 1969, the Dow was 800 and gold was $35/oz. $800 would buy either 1 Dow unit, or 22.85 oz of gold. Today, the gold is worth around $15,500 while the Dow with reinvested dividends is worth $45,000, even though the headline Dow is now only worth 19 oz of gold.
Moreover, one needs to be careful of cherry-picked starting points, no matter what the argument; even excluding dividends, for example, the Dow has sensationally performed gold since the late 1970’s.
Macro Man,
Sure, the dog ate my homework!
You follow Turkey, don’t you?…..interesting weekend there.
Indeed, an interesting turn of events. With market complacency at close to all time highs (Dow up 19 out of 21 sessions for the first time since….1929) and May a seasonally horrible month for risky assets, perhaps the Turkish army has put the cat amongst the pigeons. Stranger things have happened, viz. Iceland last year…
MM -
I understand the DJIA was launched in 1896. Any data to allow your dividend reinvestment calculation to be taken back that far, or at least further than 1969? The results must be staggering.
Guest, the data exists, but I don’t have it at hand. If memory serves, the long term nominal appreciation of the Dow is about 10% per year- of which 3% is inflation, 5% real price appreciation, and 2% dividends. Again, these numbers may be wrong- Ibbotson Associates is the best source of this kind of data, IIRC- but I think they’re ballpark.
In any event, if we strip out the dividends, w’re left with an 8% nominal gain per annum. An investment of $100 in 1896 would therefore be worth $512,904 today (1.08^111.)
Adding the dividends back in to give a long term nominal return of 10% leaves us with $3.9 million today (1.1^111).
Not for nothing did Albert Einstein call interest compounding the greatest mathematical discovery of all time!
MM -
Terrific. Thanks.
Further to Einstein’s observation, here’s my all time favorite quote on the effect of compounding on growth - maybe one that even he would have appreciated. It’s from Mark Blaug’s ‘Economic Theory in Retrospect’, edition published 1976:
“If Malthus were writing today he would no doubt have cited a recent calculation showing that if the human race had sprung from a couple living in 10,000 B.C. and had grown since then, not at the maximum biological rate but only at a modest 1 per cent per annum, the earth would now be a sphere of flesh several thousand light-years in diameter with a surface advancing into space at a rate many times faster than the rate at which light travels.”
Now you might call that a crowded trade.
I suppose the obvious question is how that first couple would have grown 1% per annum…
Assuming the parents bore the first two children at the very advanced age (back then) of 25, assuming twins for mathematical simplicity, and overlooking necessarily implied downstream incest for moral simplicity, this would start the compound growth rate at 2.81 per cent, far exceeding the assumed 1 per cent rate.
Even compound interest, while theoretically translatable to instantaneous rates of compounding, is generally not instantaneously payable. (I’d be interested in a counterexample if you know of one).
I’ll have to look back at some of the literature on historic dynamics of stock market indices some time. I know that ‘survivorship’ of index members plays a big role, but I’m too lazy right this moment to recall exactly how. There is obviously an analogous factor at work in the real world for the population mathematics cited.
Further, the instantaneous rate of growth for the first 25 years is 0 and the instantaneous rate at the birth of the twins is infinity. This is a particularly annoying aspect of the time series - head in the oven, feet in the refrigerator … tortoise and the hare … etc. etc.
(I did smile at your comment by the way).