Dubious records for trade deficit

By Dr. Paul Freedenberg
Vice President-Government Relations
AMT - The Association For Manufacturing Technology

IT IS LIKELY THAT THIS WILL be a year in which our nation will be forced to face some harsh realities. We are living beyond our means and have been for some time. The trade deficit widened to $726 billion last year, its fourth consecutive year of record loss. The multi-lateral gap of imports over exports is now almost double what it was when President George W. Bush took office.

Our bilateral trade deficit with China continued its record climb as well, with a 25 percent increase over the previous year to finish 2005 above the $200 billion level. By comparison, the trade deficit with Japan, which was almost a national obsession during the Clinton Administration, rose by a still substantial 10 percent to $82.7 billion and drew little attention.

Despite these new records, economists expect little improvement and perhaps even a slight widening of the trade gap this year. That forecast is likely to hold so long as the U.S. economy continues to grow and the rest of the world—particularly foreign central banks—continues to be willing to finance our spending. Currently, China holds more than $500 billion of our paper and Japan holds in excess of $200 billion.

Eventually, however, foreign bankers will begin to lose confidence in our ability to repay that debt. Then two things most likely will occur. First, the value of our currency will fall, and, second, we will have to pay ever higher interest rates in order to continue the flow of funds. But that has not occurred yet.

Indeed, compared to the low growth rate and inflexible economic structures of Western Europe, the United States remains a highly attractive place to invest funds. Moreover, the trade deficit is partly a result of the low economic growth rates in "Old Europe," and that is not likely to change soon.

The Administration argues that the trade deficit amounts to only 5.8 percent of the gross domestic product, and is easily manageable. Of course, they would not argue that the current rate of deficit growth can continue indefinitely, but none of the Administration's economic models have growth slowing in the next few years. Even the high cost of energy imports, which rose almost 40 percent last year on top of a similar jump the year before, does not seem to dampen the Bush Administration's optimism about the future.

As I have argued before, even if the Bush Administration is sanguine about its ability to manage the current trade imbalance, the Congress is not likely to be.

The Administration has taken its first cautious steps by complaining about China's undervalued currency in the Treasury Department's report to the Congress, and it has asked the International Monetary Fund to improve its policing of currency manipulation. However, President Bush has strenuously resisted all attempts to provide him with negotiating leverage by peremptorily rejecting various outside trade petitions on the yuan that have been filed.

This go-slow approach with China is unlikely to satisfy the U.S. Senate, where the 27.5 percent tariff, sponsored by Senators Lindsey Graham (R-SC) and Charles Schumer (D-NY), on Chinese goods is pending, and action could be taken if the Chinese refuse to enter into serious currency negotiations. Expect to see a confrontation between the Congress and the Administration over this and possibly other legislative initiatives aimed at prodding the Chinese to act on revaluing their currency upwards.

This could be the year in which there is a soft landing of the overvalued yuan, which would be the ideal solution to the growing U.S.-China trade confrontation and a great help in moving the overall trade imbalance in the right direction. But to put it in perspective, the current U.S. negotiating position is attempting to convince a Communist government—that believes that its past policies have caused a decade of 9 percent economic growth and unprecedented prosperity—to change economic course in order to facilitate a move towards a healthier world trading system. That is a highly unlikely scenario.

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