| M.D. Holloway |
05-06-2008 08:35 PM |
U.S. Trade Imbalance Receding
U.S. Trade Imbalance Receding
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By Stephen S. Poloz, Senior Vice-President, Corporate Affairs and Chief Economist, Export Development Canada
Despite six years of U.S. dollar depreciation, international trade imbalances remain a major preoccupation for financial markets and policymakers alike. What is in prospect for 2008?
The stress that comes with large trade imbalances stems from the corresponding financial flows – a country with a large trade deficit must borrow from world financial markets to finance it, and the funds implicitly come from countries with trade surpluses. Accordingly, as imbalances become large relative to historical experience, financial markets begin to worry about the sustainability of the corresponding financial flows, and the odds of a crisis or at least market volatility go up.
Just a year ago, the U.S. trade deficit was running at 6% of U.S. GDP, a very large number. That deficit has begun to shrink in the past year, however, and now stands at about 5% of U.S. GDP. Even so, this is far larger than the previous peak in the U.S. trade deficit back in 1986-89, at 3%, and markets worry that the recent retreat could prove temporary.
The increase in the U.S. deficit from around 0 to 3% of GDP during 1983-86 was accompanied by a 30-35% rise of the U.S. dollar. The greenback returned to earth during 1986-88, but the deficit stubbornly remained at around 3% of GDP. Then, the deficit declined rapidly during 1989-92, even as the U.S. dollar was rising. This underscores an important lesson: the adjustment lags between exchange rates and imbalances are so long that they can seem backwards.
Nevertheless, this suggests that there could be a big decline in the U.S. trade deficit in the next couple of years. The recent rise in the U.S. trade deficit has been driven by four things. The first is the appreciation of the dollar that took place during 1997-2002, which has now been reversed.
The second was the U.S. consumer spending boom, related to the housing bubble. That, too, is now over. Indeed, consumers may take an extended break from their high-roller lifestyle. Without the underpinning of rising house prices, a process of household balance sheet reconstruction is likely to take place during the next 12-18 months, as also happened during the early 1990s.
The third factor has been rising oil prices. Indeed, the U.S. non-oil trade deficit peaked at about 4% of GDP, and that was back in 2005. Today, the non-oil trade deficit is around 2.6% of GDP, which is a very small number, and the narrowing trend is well established. Accordingly, even if oil prices remain high, the underlying process of imbalances adjustment should continue; if oil prices retreat on the back of a global slowdown, as we expect, then the adjustment could be very rapid.
The fourth factor is the globalization of U.S. multinationals. We estimate that at least half of the U.S. trade deficit is the product of intra-firm trade. That part of the deficit might never go away, but it is being financed internally by multinationals, so it should not be a concern for markets.
The bottom line? The ingredients for a persistent improvement in international imbalances are all in place. Indeed, if the U.S. slowdown extends through 2008, the developing world maintains a decent growth outlook, and oil prices retreat, the U.S. trade deficit could narrow dramatically.
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