Intuitively, I have rejected concerns regarding the trade deficit as flawed. I lacked the data and background required to refute the arguments put forth by the bears. I found a good assessment in a book titled ‘Ride the Wave by Sherry Cooper. I’ve not quite finished the book yet, but thus far find it not far out of line with my own observations.
THE U.S. TRADE GAP-WHY THE WORLD NEEDS IT
Many market watchers and academics have argued for years that the Achilles heel of the U.S. economy is its looming trade deficit and growing dependence on foreign capital inflow. With U.S. consumers and businesses continuing to soak up imported goods and capital, many have wondered at what point the trade deficit would get too wide, stalling the great U.S. economic engine. They argued that the U.S. was too reliant on foreign capital to fund its business- and consumer-spending binge. They predicted the dollar would finally plummet as foreign investors took their money home, causing the stock and bond markets to tailspin and the economy to tank.
The Case for Concern
In 2000, the current account deficit surpassed 4.5 percent of GDP, its highest level in history. The ratio continued to rise further in 2001. This is by far the largest current account deficit in the G-7 (Figure 9.1).
A trade deficit means that a country imports more than it exports and borrows from abroad to cover the difference. The problem is that at some point, foreigners may wonder whether the borrower is capable of paying them back. And when foreigners get worried enough, they may decide it is time to pull the plug. For countries other than the U.S., history tells us that, on average, foreigners generally reach their tolerance limit at a deficit ratio of just over 4 percent of GDP-which the U.S. surpassed in the fourth quarter of 1999. The fear is that confidence in the U.S. will suddenly collapse. At the very least, capital flows could dry up.
No Crisis in Sight
Instead, the dollar continued strong through most of 2000, outpacing all the world's major currencies, and U.S. long-term interest rates fell sharply. Through the end of 2000, there was no sign that America had exceeded its credit limit with other countries, even though the stock market had sold off. After all, stocks fell everywhere. But the risks are there. Foreign ownership of U.S. stocks is proportionately far smaller than its ownership of bonds, especially government bonds. But the government bond market is rapidly shrinking with the paydown of debt.
It is highly unlikely, therefore, that foreigners would, en masse, dump U.S. Treasuries when there are so few-virtually no-substitutes. Quite the contrary- the global demand continues to grow faster than the supply. As of 2000, foreigners owned 11 percent of American stocks; but they held a whopping 44 percent of the outstanding volume of government bonds1 and 22 percent of corporate bonds outstanding. Their direct investment in the U.S.-investment in businesses and real estate- was double their U.S. equity holdings.
It is always possible that something unexpected could put the currency in serious jeopardy Once the process begins, the herd instinct could cause it to snowball. The Cassandras would tell us that as the dollar falls, import prices in the U.S. would rise, increasing inflation and causing the Fed to raise interest rates. As the economy slowed and earnings momentum turned down, stocks would sell off sharply, further escalating the dollar decline. This is the stuff of which nightmares are made, especially Federal Reserve nightmares.
Let's Look at the Facts
Things are not nearly as bleak as the doomsayers would suggest. The widening trade deficit in recent years was a reflection of strength, not weakness. The U.S. economy was the strongest in the world; not surprisingly, therefore, U.S. demand for foreign products outpaced foreign demand for American goods. The U.S., however, has a surplus in the service account that is expected to widen meaningfully over the next decade. Some predict it could ultimately surpass the deficit in goods. The U.S. dominates the trade in services. Worldwide, cross-border sales of services were around $1.3 trillion in late 2000, most of which was booked by U.S. providers. Services sold by the number-two exporter, Britain, totaled only $100 billion.
Moreover, service exports are probably woefully understated in the U.S. accounts. A proliferation of free-trade agreements around the world has blurred the boundaries between countries and made service exports that much more difficult to measure. Consider packaged software as an example. Its delivery can be via CD-ROM in a box, loaded onto a computer by the manufacturer, or downloaded via the Internet. While overseas sales of software by U.S. companies topped $13 billion as long ago as 1995, the most recent data in the U.S. balance of payments show software exports of a mere $3 billion. Clearly, accounting errors abound.
THE U.S. TRADE DEFICIT HAS SPURRED GLOBAL GROWTH
The deterioration in the U.S. trade position helped the Fed maintain a low level of inflation. Imports were a key safety valve that diverted some of the excessively strong growth in domestic demand to foreign producers. The 1998-99 global slowdown following the Asian crisis took some pressure off productive capacity constraints in the U.S. What's more, the States became a welcome market for the products of the crisis-threatened economies, allowing them to rebound more quickly. For most of the past quarter-century, in fact, the U.S. economy absorbed the world's surplus products and capital. Import prices fell as the U.S. dollar strengthened, increasing domestic competition and reducing the pricing power of American companies. This meant that the ensuing Fed tightening would be more muted and generalized inflation pressures would remain at bay.
The massive inflow of foreign capital to the U.S. stock market reflected the higher rates of return that could be earned on these investments relative to most anywhere in the world. Particularly from 1995 to 1999, U.S. business investment in technology surged, owing to a sharp rise in its rate of return. Over the same period, household savings flows slowed. Foreign capital inflows (and a burgeoning U.S. government surplus) were necessary to finance the investment spending boom. It was this very boom that triggered the surge in domestic productivity growth, lengthening the expansion, enhancing corporate profitability, and reducing inflation. Living standards rose sharply as a result. The earnings generated in foreign coffers by the booming U.S. stock market and rising currency helped them as well. It was a win-win situation.
THE DEFICIT ISN'T AS BAD AS IT SEEMS
The trade deficit is not the problem that people make it out to be. For one thing, U.S. export shipments have been rising; they grew 13 percent in 2000. Exports help manufacturers offset a softening in domestic demand, Overseas demand for high-tech equipment increased throughout most of 2000 and should trend higher as the rest of the world adopts New Economy technologies. In 2000, these high-tech exports, though decelerating, still grew roughly 25 percent, accounting for one-third of the increase in total exports, before adjusting for inflation. Other foreign shipments were also strong, but grew at a smaller 10 percent pace.
Still, exports made up no ground on the surging imports, which rose nearly 20 percent in 2000, starting from a much higher level. Nearly $3 out of every $10 spent on goods in the U.S. went to buy an import.
TRADE DATA ARE MISLEADING-MEASURING THE WRONG THINGS
The preoccupation of politicians and economists with the trade deficit as a means of "keeping score" is, however, outdated and misleading. In some cases, it is downright dangerous as it spurs a growing degree of protectionism and antiglobalization fervor, Imports and exports as they are measured today are dated concepts, left over from the accounting systems and economic models of the nineteenth century. They not only measure the wrong factors, but they measure them erroneously.2
Accurately measuring the goods that are traded is difficult enough, but it becomes even more complex for services and the other intangibles in the economy. For example, imports used to be a simple concept: products from a foreign country. But today's imports from Taiwan, for instance, include items assembled from components that were originally exported to Taiwan from other countries.
In addition, at a time when many large corporations have operations all over the world, the use of imports and exports as a measurement of national economic health is desperately outdated. Roughly 25 percent of total imports to the U.S., for example, are from foreign affiliates of American companies.
So the official definition of U.S. exports and imports is misleading and broadly understates the relative American competitive position. The reason is that sales of American goods or services to foreigners only count as an export if the goods or services are produced in the United States. But so much of American foreign sales are produced outside the country by foreign subsidiaries of U.S. companies-substantially more so for the U.S. than for any other country.
According to Joseph Quinlan, an economist at Morgan Stanley and an acknowledged expert in the field of foreign direct investment and trade, "The extraterritorial span of corporate America is unsurpassed on a worldwide basis." More than 23,000 U.S. foreign affiliates are scattered around the world. The combined total output of these companies is greater than the GDP of most countries. They employ huge numbers of people and, collectively, they are the largest exporters in the world. If you add back in all of the sales of these U.S. affiliates abroad-from Microsoft Singapore to McDonald's Moscow-and subtract out the similar sales in the U.S. of foreign products produced in the States (for example, Honda Ohio), voila! The U.S. would have a trade surplus (Figure 9.2).
Also inflating the trade deficit is the difficulty in measuring the exports (and imports) of knowledge products. Customs officials often value a computer file, for example, according to some arbitrary and irrelevant measurement system, even though the data may imbed thousands of hours of exported (or imported) labor. Often products of the highest value today are intangible or invisible. As service exports grow, they too may "disappear." The more successful service providers will set up shop in their customers' countries. We have seen this, for example, in the management consulting arena. Most large U.S. consulting firms now have offices all over the world. Their overseas sales are no longer counted
as exports.
Quinlan reports that sales of U.S.-owned affiliates in foreign countries dwarf U.S. exports by a factor of two-and-a-half to one.4 American firms compete more by setting up businesses in foreign countries-foreign direct investment-than by arm's-length trade. In short, the companies in the S&P 500 are the world's greatest export machine.
With today's globalization of production, sales by foreign affiliates of multinational companies have surpassed exports as the primary means of satisfying foreign demand. According to the United Nations, this changeover occurred in the early 1980s. Sales by all foreign affiliates reached roughly $11 trillion in 1998; world trade of goods and services ran only around $6.6 trillion that year. For the U.S. alone, in 1998, the value of exports stood at $0.9 trillion, while sales by majority-owned affiliates totaled $2.4 trillion.
This is ignored in the hand wringing over the current account deficit. The traditional measure of the trade balance misleads in assessing overall economic activity or competitiveness. U.S. companies have pursued a direct-investment strategy-building companies overseas to service home and foreign markets-more aggressively than their counterparts in most other countries, largely because of the relative strength of the U.S. dollar immediately after World War II. The dramatic appreciation of the yen until 1995 encouraged Japanese multinationals to follow the same strategy. In fact, as of 1997, there was roughly three times more Japanese direct investment in the U.S. than U.S. investment in Japan. Some of that disparity, however, was the result of Japanese barriers to entry and regulatory restrictions.
With one of the most open markets in the world and a large, prosperous middle class, the U.S. buys a vast amount of foreign goods (increasingly produced by U.S. companies with foreign workers). In addition, the U.S. absorbs the world's surplus savings that cannot be more profitably invested elsewhere. If the U.S. were not to do so, the return on capital to foreigners would be lower. This would be inefficient and improvident. Imagine the fate of Japanese or European pensioners if they were locked solely into low-interest domestic savings vehicles.
No DEBT TRAP
As productivity growth surged in the 1990s, augmenting the potential, noninflationary growth of the economy, the sustainable current account ratio also rose. This was reflective of an inevitably rising trade deficit, as we have seen. Plus, if intra-firm trade is exaggerating the real trade deficit, then foreign claims on the U.S. created by the same deficit are also exaggerated because many of these so-called foreign firms are American.
Even more important, the U.S. is the world's key-currency country. It plays a central role in providing global liquidity and reserve assets. In today's world, the U.S. could not suffer the classic "debt trap" that so many traditional economists are concerned about.
The U.S. dollar will continue fluctuating to equilibrate global financial flows. Multinational companies adjust their intra-firm trade flows accordingly, helping to stabilize the system.
BOTTOM LINE ON THE CURRENT ACCOUNT DEFICIT
The U.S. current account deficit plays an important role in the stability of the global financial and economic system. The U.S. acts as a worldwide clearinghouse, helping to absorb the world's excess capital and goods. The dollar is used as a reserve currency for global central banks. They helped fund the deficit to the tune of more than $50 billion in 2000. The world needs dollars to conduct day-to-day business. The world's major commodity, crude oil, is bought and sold with dollars. Developing countries export and import with dollars.
Global dollar demand is also strong because of currency needs in countries like Russia, Turkey, and much of the developing world. There, the demand for U.S. dollars is strong, as domestic currencies are seen as less reliable. The dollar is the "unit of exchange" in the global underground economy. Try doing a multimillion-dollar drug deal in rubles or loonies (Canadian dollars). It is also the peg for currencies in Hong Kong and Argentina. Unless the euro or the yen begins to take over these key currency functions, which seems unlikely in the foreseeable future, the U.S. current account deficit will be the cushion and it will provide no imminent threat to the outlook. |
