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Shhh.. don’t tell any one. The US trade deficit is getting worse, not better

by Brad Setser
June 10, 2008

The $60.9 billion monthly April trade deficit was the largest monthly deficit since last March. So much for the notion that the trade deficit has turned the proverbial corner.

One price explains it all: $96.81

That is the average price of US imported petrol in April.

It is about $30 a barrel above the average price for imported petrol in 2007

And it is about $30 a barrel below the current market price for petroleum. The deterioration in the US petroleum deficit isn’t over.

If the average price of imported petrol stabilizes at $125 a barrel (the US imports a fair amount of heavy crude so its average import price is below the market price for sweet light crude, the US petroleum import bill will rise from a bit under $320 billion in 2007 to around $520 billion in 2008.

Not good.

The petroleum deficit – over the last three months – already exceeds the non-petroleum deficit.

trade-april-1-balance.JPG

Note though that the improvement in the non-petrol deficit has stalled just a bit. That is something to watch going forward.

Unless something changes, the US trade deficit is set to increase in 2008. Yes, increase. The improvement in the non-petroleum deficit, on current trends, won’t be enough to offset the $200 billion rise in the petroleum deficit.

That deficit isn’t financed by private capital flows either. Accurate data on official flows isn’t available (the US data understates official inflows). But I am confident that the increase in the assets of central bank and sovereign funds is on track to be around $1.5 trillion in 2008 – evenly split between the oil exporters and China. Even if only half that increase is held in dollars, it would be roughly enough to finance the US deficit if private inflows and outflows balanced. No one can credibly argue that the large US deficit is a fully market outcome, one produced by strong private demand for US assets.

The rest of the data release was fairly balanced, with goods news on exports offsetting a rise in non-oil imports. Non-oil export and imports both rebounded from their March lows in both nominal and real terms.

The overall story really hasn’t changed. Import growth has slowed, and export growth – especially nominal export growth – is very very strong.

trade-april-2-nominal-growth.JPG

And yes, the improvement in export growth does seem correlated with the fall in the dollar’s real value. Consider a chart showing y/y nominal export growth v the dollar’s real value (on the BIS index)

trade-april-3-exports-rer.JPG

Real goods export growth – on a year over year basis – looks fine. The dip in real goods exports that worried me a couple of months ago wasn’t confirmed in the April data. Note that real non-oil goods import growth is very weak — with negative y/y growth. That is consistent with Dr. Chinn’s views about the current health of the US economy.

trade-april-4-real-growth.JPG

And the real non-petroleum and petroleum deficit are both improving.

trade-april-5-real-levels.JPG

Oil import volumes are down 7% y/y in 2008. Price changes do have an impact.

* Credit for all the graphs should be shared with Arpana Pandey of the Council on Foreign Relations

30 Comments

  • Posted by s

    Expect a change in reporting to core trade balance. Problem solved.

  • Posted by bsetser

    lol (in textese)

  • Posted by Howard Richman

    Brad,

    In our 2008 book, Trading Away the Future, we predicted that the slight fall in the trade deficits in 2007 would be a temporary blip and that the trade deficits would eventually resume their steady climb upwards.

    Our reasoning was simple: More and more countries are following the Chinese mercantilist policy of purchasing dollars in order to increase their exports to the United States and reduce their imports from the United States. Don’t forget that our trade deficit with China went up during 2007, even though our trade deficits with Europe and Latin America were falling.

    Keep in mind that the trade-equilibrium-exchange-rate is shifting. As mercantilism succeeds, the mercantilist countries get investment in their trade sectors while the victim countries do not. The result is that their trade surpluses with the United States continue to increase even while their currency strengthens versus the dollar.

    By the way, you’ve never requested a free review copy. Just e-mail me your snail mail address and I’ll send you one.

    Howard Richman
    howard@pahomeschoolers.com
    http://www.trade-wars.blogspot.com

  • Posted by Dave Chiang

    Howard Richman,

    Oh please Howard, the Chinese are just as much a victim of high oil prices as the United States and Europe. The Chinese economy is a net importer of oil with around 3 million barrels per day imported out of the 7 million barrels per day consumption. But why aren’t you asking why Americans are such gluttons of oil consuming 20 million barrels of oil per day. With a population of 1.3 billion, the Chinese consume far less energy both on a per capita basis and on an absolute total consumption basis. Your economic arguments bashing the Chinese for their energy consumption hold no water.

  • Posted by Dave Chiang

    ‘Perhaps 60% of today’s oil price is pure speculation’
    by F. William Engdahl

    ‘The tail that wags the dog’

    All this is well and official. But how today’s oil prices are really determined is done by a process so opaque only a handful of major oil trading banks such as Goldman Sachs or Morgan Stanley have any idea who is buying and who selling oil futures or derivative contracts that set physical oil prices in this strange new world of “paper oil.”

    http://www.globalresearch.ca/index.php?context=va&aid=8878

  • Posted by Twofish

    Blame Wall Street… Fun to be a human target for everything wrong in the world. Also wildly wrong…

    Check out todays FT article:

    Speculators badly burnt by soaring oil prices

    Betting on rising oil prices is much, much harder than it sounds.

  • Posted by don

    Howard Richman –
    I haven’t seen your book, but I think you are on the right track. Brad’s concern about the growth of U.S. dollar-denominated debt is, too. Sometime the party will have to end, and I think it will be in tears. Unfortunately, I fear the end will not come soon enough to avert a really big catastrophe for all involved. BB and the U.S. government are responding to the current slowdown by trying to maintain national borrowing, when we already have huge excess demand.
    The yen carry trade is partly supported, I believe, by the notion that Japan will not let the yen appreciate to much below 100 per dollar. So, Japan may not be free from mercantilism, either. Paulson and BB show an alarming tendency to ignore an underlying structural problem when they talk about a ‘strong dollar.’ I think they should differentiate between the overvalued euro and the undervalued Asian currencies.

  • Posted by gillies

    i.wonder.how.the.party.ends,though?…

    it.can.end.with.the.dollar.collapsing,.but.i.do.not
    think.so.

    more.likely.global.trade.collapses.and.the.dollar
    bottoms.out.in.a.deflationary.slump.

    if.oil.fell.to.$40/barrel.the.dollar.would.make.a
    corresponding.recovery.on.that.account.at.least.

    and.the.dollar.might.become.an.even.more.dominant
    global.currency.

    those.with.the.power.to.collapse.the.dollar.might.prefer.
    instead.to.negotiate.an.end.to.the.feds.monopoly.

    a.globodollar.with.a.cap.on.issuance.set.by.a.committee
    of.seven.or.eight.or.ten…

    financial.unilateralism.directly.contradicts.globalisation.

    in.the.long.run.this.has.to.be.resolved….somehow.

    the.other.great.contradiction.is.the.cost.of.the.military
    defence.of.the.united.states.economy.which.is.itself.the
    main.drain.on.that.economy.

    like.a.dinosaur.going.down.under.the.weight.of.its.own
    armour.plating.

    the.trade.deficit.would.surely.improve.if.you.*printed*
    less.money.?…you.cannot.build.an.economy.on.policies.
    tailored.to.those.who.live.by.gambling.*on.margin.*

    the.answers.are.obvious.to.those.who.know.less.about.it.!

  • Posted by Howard Richman

    Chiang: You are definitely correct that China is just as much a victim of the rising oil prices as the United States.

    Don: I agree with everything you wrote. By the way, the United States is also subsidizing the Japan carry trade by not charging income tax on interest earned in the U.S. by private foreigners.

    Gillies: I don’t know how it will end either. If nothing is done, I agree with Don that it will end in tears. Here’s our prediction from Chapter 9 of our book:

    As we noted earlier, most economists still believe that free market forces will “automatically” fix the trade deficits. They are like ostriches living with their heads tucked in the sand. These economists are correct that, normally, a system of freely fluctuating exchange rates would indeed cause the currency of a trade-deficit country to lose value relative to the currencies of the trade surplus countries and thus stimulate exports and discourage imports and bring an end to trade deficits. They just don’t understand that the trade deficits are being deliberately caused by governments. In their ignorance, they have been making failed prediction after failed prediction.

    First, they thought that America’s federal budget deficits were largely causing the trade deficits. They predicted that with fiscal austerity the trade deficits would decrease. They were wrong. When President Clinton and the Republican congress brought the federal budget into surplus in the 1990s, the dollar mercantilist governments expanded their loans to the United States and the trade deficits grew.

    When for a while America’s trade surplus in services was growing while our industrial base was declining, they expected the trade surplus in services to continue to grow. They were wrong. Due to the dollar mercantilists, the trade surpluses in services followed the trade deficits in goods on the downward trajectory.

    When US assets were valued highly as a result of the low interest rates caused by the dollar mercantilists, they proclaimed that the trade deficits were really a good sign. Foreigners were sending their money to the United States because the United States was such a good place to invest. They were wrong. It soon became evident that money invested abroad paid off much better than money invested in the United States, but still the inflows of savings from the dollar mercantilist governments increased.

    The result has been a continuing decline in our industrial base and declining prospects for America’s future. In August 2006 Dan R. Mastromarco, a principal in the Argus Group economics consulting firm, discussed the sad future that simulations of the US economic future were predicting:

    “Recent simulations under the current system show capital per unit declining 5 percent over the course of the century for an 18 percent decline over the long-run in after-tax take-home pay.”

    As foreigners continue to purchase US financial assets and the United States continues to lose industries, China will emerge as the dominant political and economic power in the world.

    This scenario is the current situation. However, as wise economist and presidential advisor Herb Stein once said: “If something cannot go on forever, it won’t.” The huge trade deficits cannot and will not go on forever. As foreigners purchase more and more US assets, the income that they receive from those assets will grow and grow. Eventually the flow of this income out of the United States would cause a landing to occur, but one in which a debt-loaded United States is poor and weak….

    Howard

  • Posted by Dave Chiang

    Twofish,

    Wall Street Speculator George Soros in testimony on Capitol Hill on Tuesday stated that commodity index funds, which treat oil as an asset rather than a commodity to be bought and sold for use, are creating an energy bubble.

  • Posted by bsetser

    gillies — the fed isn’t actually issuing that many dollars. look at the data on the fed’s balance sheet. it isn’t growing that fast — as a senior economist at a major wall street firm noted privately to me. Neither the fed’s total assets nor total liabilities have increased much (there have been big changes in the composition of its assets but that is a different story). The fed has been able to lower policy rates without printing much money/ growing its balance sheet.

    the really fast money growth these days is found in the emerging world (China, the Gulf, Argentina) not the US. You don’t need a committee to control dollar issuance to change that; these countries could stop pegging to the dollar. Their central bank balance sheets are growing fast — on both the asset and liability side.

    Incidentally, if the US cuts rates and it pushes the dollar down, the logic above suggests that dollar weakness would contribute to an improvement in the trade balance — though I would concede that to the extent $ weakness contributes to the rising $ price of oil, there is now an important offset that is slowing the adjustment.

  • Posted by glory

    vietnam devalues (the dong ;)

    perhaps if they’d revalued sooner they might not have had to devalue ‘later’… a prelude/lesson for other currency managers & peggers? i.e. beware the perils of real exchange rate adjustment!

  • Posted by Dave Chiang

    Howard,

    The world is moving to a multi-polar global order led by the BRIC nations. There has never been nor will there ever be any nation powerful enough to impose control over the entire planet. The Chinese aren’t Neo-con lunatics who aspire for global hegemony. China will rise back to its historical role as the regional power across East Asia. The last century characterized by the Cold War era was an aberration. The world is simply returning back to its historical state pre- Cold War. US influence will decline in non-Western regions of the world which don’t share similar cultural values with Americans.

  • Posted by Dave Chiang

    Brad, can you respond to comments by John Williams at Shadowstats.com . The US Federal Reserve is de facto massively expanding the US money supply as measured by the SGS-Ongoing M3 measure, which currently shows a record annual growth rate of 17.3.

    ” The efforts by the federal government and the Federal Reserve to prevent a systemic collapse as a result of the banking solvency crisis has started to spike broad money growth, as measured by the SGS-Ongoing M3 measure, which currently shows a record annual growth rate of 17.3%. While the Fed has not been formally creating new money — yet — by adding to reserves, it has had the effect of creating new money by re-liquefying otherwise illiquid banks, by lending liquid assets versus illiquid assets. As a result, a number of banks have been able to resume more normal functioning, lending money and creating new money supply. As the systemic bailout proceeds, formal money creation will follow and already may be starting to show up in official accounting. ”
    http://www.shadowstats.com/article/292

  • Posted by Twofish

    Richman: These economists are correct that, normally, a system of freely fluctuating exchange rates would indeed cause the currency of a trade-deficit country to lose value relative to the currencies of the trade surplus countries and thus stimulate exports and discourage imports and bring an end to trade deficits.

    Unless one of the countries has a currency that is used as the world’s reserve currency and there isn’t a mechanism like the IMF to bail out nations with a currency crisis. The fact that the US runs a trade deficit is related to the fact that it is used as the world’s reserve currency, and that fact has been known since the 1960′s.

    Richman: The dollar mercantilist governments expanded their loans to the United States and the trade deficits grew.

    They shrink as a percentage of GDP throughout the 1990′s.

    Richman: As foreigners continue to purchase US financial assets and the United States continues to lose industries, China will emerge as the dominant political and economic power in the world.

    Not for decades. The Chinese economy is still decades behind the US economy as far as size and productivity. Also unlike the US, China, at this point, has no particular desire to be the dominant political and economic power in the world. China is too focused on basic survival to dream about these things right now.

  • Posted by Twofish

    Richman: Eventually the flow of this income out of the United States would cause a landing to occur, but one in which a debt-loaded United States is poor and weak….

    I think you are far too pessimistic about the future of the United States. The US economy is huge and the amount of outward debt does not seem to me to be unsustainable.

    As long as the US keeps its borders relatively open and remains the place where imported capital meets imported labor, its got a wonderful future ahead of it.

    Remember that all of the people who were saying that an economy would collapse from US-Japan trade in the 1980′s were right, they were just wrong about which economy. The problem with merchantilist policies is that they are inherently a very bad way of running an economy.

    Historically the first example of a mechantilist economy was that of Spain. During the 17th century, you had massive amounts of gold and silver entering Spain. The basic problem with accumulating gold, silver or dollars is that unless you spend it, gold, silver, and dollars don’t produce anything, and China and the Middle East are ending up with inflation for many of the same reasons that Spain did. You have massive amounts of dollars coming in, and they aren’t doing anything useful.

  • Posted by Twofish

    Richman: As we noted earlier, most economists still believe that free market forces will “automatically” fix the trade deficits.

    Actually I don’t know of too many economists that would think that.

    don: Unfortunately, I fear the end will not come soon enough to avert a really big catastrophe for all involved.

    Norse mythology is relevant here. The Norse gods know that they are fated to fail in their war against the giants. They just don’t know when.

    Economies are always of the edge of catastrophe. If you look at economic history for the last thousand years, things are *always* on the verge of falling apart. What’s more is that you are doomed. You cannot prevent an economic catastrophe from happening. One will happen someday.

    What you can do is to put off the end for another year or another decade. Someday you will be doomed to fail, but the best you can do is to put off the end for another day.

  • Posted by JKH

    “the fed isn’t actually issuing that many dollars. look at the data on the fed’s balance sheet. it isn’t growing that fast — as a senior economist at a major wall street firm noted privately to me”

    A meaningful point – somebody should put it on a banner, rent an airplane, and fly it over the blogosphere for a few weeks.

  • Posted by Howard Richman

    Twofish:

    I was especially wondering about the basis for your statement that foreign government loans to the United States shrank as a percentage of GDP throughout the 1990s, as I have never found a reliable source for foreign government dollar reserves pre-1995. (Since 1995 these reserves can be estimated from the IMF’s COFER database.)

    I just now looked back at the COFER data and found that foreign dollar reserves were about 11% of our GDP in 1995 and 14% of our GDP in 2000. What do your statistics say about those years?

    As far as your analysis of Chinese intentions, I disagree. I think that they would like nothing better than to replace the United States as the world’s major military and political power. Did you read Michael Ledeen’s think piece in the Far Eastern Economic Review, “Beijing Embraces Classical Fascism”? Here’s the link to the piece:

    http://feer.com/essays/2008/may/beijing-embraces-classical-fascism?searched=ledeen&highlight=ajaxSearch_highlight+ajaxSearch_highlight1

    And here’s the link to his blog. Check out the May 30 entry in which he notes that the Chinese government censored all of the paper copies of it:

    http://pajamasmedia.com/michaelledeen/

    Howard Richman
    http://www.trade-wars.blogspot.com

  • Posted by Twofish

    jkh: “the fed isn’t actually issuing that many dollars. look at the data on the fed’s balance sheet. it isn’t growing that fast — as a senior economist at a major wall street firm noted privately to me”

    But the contents of the balance sheet have changed dramatically. Over the last two months, it’s sold close to $300 billion in treasuries in exchange for illiquid mortgages and IOU’s in the form of term auction credits.

    It’s pretty extraordinary.

  • Posted by Howard Richman

    Twofish:

    Your discussion of Spanish mercantilism is a bit inaccurate. The relevant century was the 16th Century, which is the century that France, England and the other mercantilist powers succeeded with stealing Spanish industry. That century ended with the failure of the Spanish Armada’s attempted invasion of England, marking the end of Spain’s rein as the dominant power.

    Adam Smith justly derided mercantilism as being based upon the wrong goal. Indeed, the goal of the mercantilism of the day was to collect as much gold as possible because gold gave a monarchy the power to engage in foreign wars. The Spanish got their gold by stealing it from the Incas. England and France got their gold by encouraging their exports and restricting their imports. One of the main points of Smith’s “Wealth of Nations” is that a nation’s well being should be measured by its GDP (though he didn’t call it that), not the amount of gold in its treasury.

    As you point out, when the goal of mercantilism was to collect gold, it eventually failed. The additional gold becomes part of the money supply and causes inflation.

    The goal of the modern mercantilist nations is quite different. Their goal is to steal industries, not collect dollars or gold. When they get dollars, they lend them back to Americans (directly or indirectly) just as fast as they can.

    I completely disagree with your analysis that the inflation in China at the moment is directly caused by their dollar accumulations. Unlike the gold of the 16th century, dollars in 21st century China are not a medium of exchange. That medium in China is the yuan (RMB).

    The rising inflation in China is probably either due to the rising cost of imported oil and/or the expansion of the Chinese money supply. I suspect that it is due to both.

    Howard

  • Posted by Mark

    “The fed has been able to lower policy rates without printing much money/ growing its balance sheet”

    Could you please explain this comment.

  • Posted by Jeff Benson

    Brad,
    I think the interesting question is now, what is the correlation between consumer spending and oil consumption. If the average american consumes less oil, doesn’t it implicity mean they are traveling less and therefore slowing the velocity of money with fewer transactions?

  • Posted by bsetser

    Jeff — I am not sure that there would be a fall in the velocity of money. less consumption (meaning fewer barrels imported) doesn’t mean less spending on oil (’cause the price is higher), and nominal spending is what should count here.

    2fish — I agree that the change in the composition of the fed’s balance sheet has been nothing short of extraordinary. my point was only that its overall size hasn’t grown.

    Mark — if you look at either the asset side of the fed’s balance sheet (its holdings of treasuries and other securities) or its liability side (cash outstanding + banks mandatory reserves with the fed) there hasn’t been a big change. This contrasts with the last easing cycle, which was — i think — accompanied by a much larger growth in the size of the fed’s balance sheet. The easiest way (I think, this isn’t my true area of expertise) to explain the fall in US rates absent a major increase in the supply of base money is that demand for money (at any given interest rate) has fallen as a result of the crisis. If the fed had wanted to keep rates higher, it would have needed (in this theory) to have reduced base money.

    In some sense though the precise explanation doesn’t matter so much — the key is that the fed hasn’t (objectively) been running the printing presses. Data on cash in circulation is released every thursday and it just hasn’t increased much.

    Emerging market central banks that peg to the $ by contrast have been running the printing presses — and expanding the size of their balance sheets significantly.

    DC — I didn’t follow m3 when the fed tracked it, and I haven’t started following it just b/c the fed stopped tracking it. maybe that is an oversight on my part, but my training is as a balance of payments economist and i have enough on my plate as is … now if you could just convince the CIC and the gulf SWFs to disclose more data, i could save a lot of time and maybe follow more variables.

  • Posted by artichoke

    Twofish:

    Yes the Fed has sucked $300 billion out of the real economy and given it to banks to bail out them and their creditors.

    Criminal.

    By the way (speaking of crimes) we should start enforcing the EEO laws that require you to try to find a qualified American before hiring a foreigner, especially in those same banks that are being bailed out with our money.

    Cheers!

  • Posted by Twofish

    artichoke:Yes the Fed has sucked $300 billion out of the real economy and given it to banks to bail out them and their creditors.

    Yeah. It’s horrible that the Fed bails out people that the banks owe money to.

    Sayyyyy…..

    Just out of curiosity, do you have any sort of checking or savings account? Maybe you don’t. But does your employer have some sort of checking or savings account….

    Now what is a bank account. It’s when you hand some money to a teller, and they give you a slip of paper promising that you can take out the money when you want. I guess that makes the person with a bank account a creditor (i.e. someone that the bank owes money to).

  • Posted by JKH

    “It’s pretty extraordinary.”

    Yes. So is China’s reserve accumulation.

    The difference (as Brad notes indirectly) is that the Fed is fully sterilizing the effect of its new asset activity. PBOC isn’t.

  • Posted by gillies

    i.hate.to.admit.it.

    but.mr.medvedev.and.dave.chiang.and.i.are.in.agreement.

    http://www.reuters.com/article/ousiv/idUSL0749277620080607?sp=true

    the.geopolitical.tide.will.run.against.financial.unilateralism

    fairly.or.unfairly.a.slump.will.be.blamed.on.incompetence.

    failure.to.control.financial.operators.in.the.general.
    interest.

    a.move.to.a.globally.monitored.reserve.currency.

    ending.the.bretton.woods.picnic.

  • Posted by mxq

    the U.S. trade deficit is misreported, as half involves intra-company trade (according to Marc Chandler at tsc)

    He also said:

    The dollar is still the currency of choice 65% of the time, and that shows no signs of changing. In fact, foreigners bought another $230 billion in Treasures and agencies in the first five months of this year.

    Foreign Direct Investment, which rose 60% year/year in the second half of 2007, is sitll rising at a very fast clip.

  • Posted by bsetser

    mxq — the trade deficit is correctly reported. intracompany trade can still result in a new flow of funds out of the US. US firms producing in china pay Chinese salaries and the like.

    the profits from such production enter into the US BoP in the income balance. that is as it should be.

    tis true that foreigners bought large sums of treasuries and agencies. we even know who those foreigners are: central banks, and specifically the PBoC. When US and other firms producing in China want to convert $ into RMB, they sell those $ to the PBoC …

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