Smith Faculty Opinion Article	August 10, 2006
By Dr. Peter Morici, Professor of International Business EMAIL WEB SITE

U.S. Trade Deficit Eases in June but Will Head North Through the Summer

Today, the Commerce Department reported the June trade deficit on goods and services was $64.8 billion, down from $65.0 billion in May but up from $63.3 billion in April.

The petroleum deficit fell to $24.7 billion in June from $25.8 billion in May, but was up from $21.0 in April. Prices rose in June but import volumes fell. The oil import bill is likely to rise in July and August, because of tightening conditions in Middle East markets and the shutdown of significant production in Alaska.

Also, imports from China continued to move up.

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 by foreigners investing in the U.S. economy or lending Americans money. Direct investment in U.S. property and productive assets provides only a small portion of the needed funds, and the balance is obtained through the sale of Treasury securities, corporate bonds, bank accounts, and other paper assets. 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.

The China Factor

The June trade deficit with China was $19.7 billion, up from $17.7 billion in May. Moreover, China reported a record global trade for July, indicating the U.S. deficit with China worsened sharply in June.

This situation is likely to worsen. The dollar remains at least 40 percent overvalued against the Chinese yuan, and significantly overvalued against other Asian currencies.

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 closely and currently is trading at about 7.96.

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.

To limit appreciation of the yuan against the dollar, the Chinese central bank purchases more than $200 billion in U.S. and other foreign securities each year. 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.

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

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.

Politics, Protectionism and the Trade Deficit

Treasury Secretary Henry Paulson urgently needs to persuade China to significantly revalue the yuan; however, President Bush has been reluctant to give his Treasury Secretary levers that could move China to action.

For example, the Bush Administration opposes a bipartisan bill sponsored by Congressmen Duncan Hunter (R-CA) and Tim Ryan (D-OH) that 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.

President Bush's reluctance to tackle currency issues and other industrial policies unfairly 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. Similarly, large retailers like Wal-Mart, Target and Staples stock their shelves and pad their profits with subsidized Asian imports.

Now, these multinationals and retailers are profiting from Asian protectionism and systematically oppose strong action by Washington to reverse the effects of protectionism. They have become strong advocates of Chinese protectionism and Beijing's most effective lobby in Washington.

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