Smith Faculty Opinion Article	July 19, 2006
By Dr. Peter Morici, Professor of International Business EMAIL WEB SITE

U.S. Trade Deficit Rises in May and Will Likely Increase Further

Today, the Commerce Department reported the May trade deficit on goods and services was $63.8 billion, up from $63.3 billion in April and $61.9 billion in March

The petroleum deficit increased to $25.4 billion in May from $21.0 billion in April and $20.0 billion in March, as both the volume and price of imports jumped substantially.

Imports from China and other sources in Asia moved up, and reports from Beijing that Chinas global trade surplus soared in June indicate the bilateral trade gap with China will continue to swell.

Tightening conditions in international oil markets and rising imports from China will soon push the annual trade deficit to $800 billion, imposing a significant drag on economic growth.

The trade deficit must be financed either by foreigners investing in the U.S. economy or loaning Americans money. In the first quarter, direct investment in U.S. property and productive assets only provided 6.8 percent of the needed funds, and the balance was obtained through the sale of U.S. Treasury securities, corporate securities, bank accounts, currency, and other paper assets. Essentially, Americans borrow nearly $60 billion each month to consume more than they produce. The total debt will exceed $6 trillion by the end of 2006.

Treasury Secretary Henry Paulson urgently needs to persuade China to significantly revalue the yuan, and the Bush Administration and Congress should take more credible steps to reduce dependence on foreign oil.

The China Factor

The Wal-Mart effect is broadly apparent. The May trade deficit with China was $17.7 billion, up from $17.0 billion in April. Moreover, China recently reported its global trade surplus jumped 11.5 percent in June, indicating the U.S. deficit with China worsened sharply in June.

In the months ahead, this situation is likely to continue to deteriorate. 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 in July 2005 and announced it would adjust the currency to a basket of currencies, the yuan continues to track the dollar very closely. Currently, the yuan is trading close to 8.00.

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

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 Chinas 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.

In his semiannual reports to the Congress, former Treasury Secretary John Snow did not cite China for manipulating the yuan to accomplish competitive advantages for its exports. Instead, Snow chose diplomacy and achieved meager success.

Henry Paulson, having strong ties and greater experience in China, may be able to accomplish better results than Mr. Snow, but President Bush has been reluctant to give his Treasury Secretaries significant levers that could move China.

The Bush Administration opposes several bills in Congress that would enable actions to offset Chinese currency subsidies. For example, a bipartisan bill by Congressmen Duncan Hunter (R-CA) and Tim Ryan (D-OH) would add the subsidies provided by currency manipulation to the list of unfair trade practices actionable under U.S. countervailing duty law, and permit domestic manufacturers to petition the Department of Commerce and U.S. International Trade Commission for duties on Chinese imports to offset these subsidies.

Were the Bush Administration to merely support passage of Hunter-Ryan or similar legislation, Secretary Paulson's hand with China would be greatly strengthened.

No Help from the Doha Round

Another factor driving up U.S. trade deficits are lopsided WTO rules. For example, these permit China to enforce investment rules on U.S. multinationals that limit imports of components and services, and to subsidize Chinese manufacturing with zero interest loans.

Also, WTO rules permit many major trading countries to rebate value-added taxes on their exports and impose these taxes on imports. The United States is much more dependent on corporate and personal income taxes to finance government than other countries, and WTO rules prohibit the United States from making similar border tax adjustment for income taxes on exports and imports.

The average standard value-added tax in the EU is 19 percent. When rebated on exports and applied to imports, these adjustments provide a 19 percent subsidy on EU products sold in U.S. markets and a 19 percent import tariff on U.S. products sold in EU markets. China offers similar benefits to its manufacturers.

Special and differential treatment under WTO rules permits developing countries to maintain prohibitively high tariffs on many manufactures and a plethora of other trade barriers under the guise of promoting economic growth. Those block U.S. exports of technology-intensive goods and services.

The Doha Round, even if it reaches a deal on agriculture will do little to relieve these problems. Currency manipulation, investment rules, most subsidies, and the unequal treatment of domestic taxation are not on the negotiating agenda.

A successful Doha Round would increase U.S. exports about $7.5 billion a month. Subtracting additional imports, this would hardly dent the $64 billion monthly U.S. trade deficit.

Politics, Protectionism 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 Caterpillar, GE and GM, to move production to China, India and other Asian destinations. Now, these companies, profiting from Asian protectionism, systematically oppose strong action by Washington to reverse these practices. They become Beijing's most effective lobbyists in Washington.

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 autoparts, textiles, furniture, and offices, and for wages of ordinary working Americans, contribute to poor approval ratings for President Bush. This fallout could prove the undoing of the Republican majority in House of Representatives this fall.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.