Smith Faculty Opinion Article	June 9, 2006
By Dr. Peter Morici, Professor of International Business EMAIL WEB SITE

U.S. Trade Deficit Rises in April: A Threat to Growth, Limits Fed Options

Today, the Commerce Department announced the April trade deficit was $63.4 billion, up from $61.9 billion in March.

Petroleum imports played a key role. The volume of imports fell a bit but petroleum prices jumped. The net deficit on petroleum increased from to $21.0 billion in April from $20.0 billion in March. This trend is likely to continue through the summer.

Imports from China and other sources in Asia moved up, and this trend is likely to continue at a brisk pace.

Surging sales of Chinese consumer are pushing up the trade deficit. The trade deficit, along with higher gasoline prices and the flagging housing sector, will slow GDP growth in the second and third quarters.

All of this makes more difficult the challenges faced by Fed Chairman Ben Bernanke.

The China Factor

The Wal-Mart effect is broadly apparent. The April trade deficit with China was $17.0 billion, up from $15.6 billion in March.

This situation is likely to become worse in the months ahead. The dollar remains at least 40 percent overvalued against the Chinese yuan, and significantly overvalued against other Asian currencies too.

China continues to peg against the dollar. Although China revalued the yuan from 8.28 to 8.11 last July, and announced it would adjust the currency to a basket of currencies, the yuan continues to track the dollar very closely. Currently it is trading at about 8.01.

China is permitting the yuan to appreciate less than 4 percent a year. Since the implicit value of the yuan rises about 5 percent each year, the yuan will remain at least 40 percent overvalued for the foreseeable future.

In its semiannual report on currency practices, the Bush Administration did not cite China for manipulating the yuan to purposely accomplish competitive advantages for its exports and to prevent adjustments in Chinas global trade surplus and its bilateral surplus with the United States. Hence, no change in Chinese currency policy should be anticipated soon; the yuan may gradually rise in value but not enough to help correct global or U.S. trade imbalances.

Each year, the Chinese central bank purchases more than $200 billion in U.S. and other foreign securities to keep the value for the yuan from rising against the dollar. This comes to about 9 percent of its GDP, and about one-quarter of its exports. These purchases provide foreign consumers with 1.6 trillion yuan to purchase Chinese exports, and create a 25 percent subsidy on foreign sales of Chinese goods. Clearly, this contributes to global trade imbalances and is why the G-7 has urged China to alter its currency policy.

While economists may disagree about how much or through what methods China should revalue the yuan, it defies sound economics and common sense to deny that massive Chinese intervention is suppressing the value of yuan or increasing the U.S. trade deficit with China. Moreover, Chinas policy compels other Asian governments to follow similar policies and limit revaluation of their currencies against the dollar.

U.S. manufacturers are particularly hard hit. Chinas currency market intervention creates a 25 percent subsidy on its exports, and competitive advantages in industries not dependent on low-wage labor. Other Asia economies follow suit with similar industrial policies. Through recession and recovery, the U.S. manufacturing sector has lost 3 million jobs. Following the pattern of past economic recoveries, the manufacturing sector should have regained about 2 million of these jobs, especially given the very strong productivity growth accomplished in the durable goods segment and throughout manufacturing.

Trade Deficits and Fed Policy

High and rising U.S. trade deficits make Ben Bernanke's job at the Fed more difficult by reducing productivity and the growth potential of the U.S. economy.

Workers in export and import competing industries are 50 percent more productive and earn higher wages than workers elsewhere in the economy. Export and import competing industries spend three-times the national average on R&D. Hence, large trade deficits, by redeploying workers and capital from industries competing in global markets, substantially reduce labor productivity, wages, and investments in new products and business methods. By lowering wages, trade deficits have significantly reduced adult participation in the labor force.

With smaller trade deficits, higher productivity growth would curb inflation, and the Fed could accommodate stronger GDP growth as it manages interest rates.

Cutting the trade deficit in half would boost employment and productivity enough to raise GDP by $300 billion or about $2000 for every working American. The wages of many workers would not be lagging inflation, and ordinary working Americans would more easily find jobs paying good wages and offering decent benefits.

Longer-term, increased productivity growth would increase the potential for non-inflationary growth by 25 percent a year.

These long term effects on growth are cumulative. Thanks to the record trade deficits under President Bush, the U.S. economy is about $1 trillion smaller. This comes to nearly $7000 per worker.

Politics, Currency and the Trade Deficit

President Bush's reluctance to tackle currency issues and government incentives advantaging industries in Asia creates strong incentives for large U.S. multinationals, such as IBM, GE and GM, to move production to China, India and other Asian destinations. Now that these companies have investments in the region, they are reluctant to support strong action by Washington to reverse these practices.

Similarly large retailers, like Wal-Mart, Target and Staples, importing goods from Asia have sought to stem U.S. government efforts to address these policies.

The consequences of the trade deficit for industries in the Middle West and South, such as auto-parts, textiles, furniture, and school supplies, and for wages of ordinary working Americans contribute to poor approval ratings for President Bush even as the economy enjoys robust growth. This fallout could prove the undoing of the Republican majority in House of Representatives this fall.

Peter Morici is an economist and professor at the Robert H. Smith School of Business at the University of Maryland. He is a recognized expert on international economics, industrial policy and macroeconomics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission.