Smith Faculty Opinion Article	October 11, 2007
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

U.S. Records $57.6 Billion Trade Deficit in August
Deficit Lowers GDP $1750 for Each Working American

Today, the Commerce Department reported the August deficit on trade in goods and services was $57.6 billion. This was down from $59.0 billion in July, but the trade deficit still is about 5.0 percent of GDP and remains a big drag on economic growth and incomes. The consensus forecast was $59.0 billion, and my published forecast was $58.1 billion.

In 2007, the trade deficit will reduce GDP by about $250 billion, and interest payments on foreign borrowing ads another $300 billion to this loss. By lowering productivity and requiring interest payments to foreigners, the trade deficit imposes a tax on Americans equal to about four percent of GDP, and this burden increases about $50 billion each year.

Composition of the Trade Deficit, the Dollar and New Trade Agreements

In August, the deficit on trade in goods was $66.6 billion, while the surplus on services was $9.0 billion.

Services income includes U.S. $5.8 billion in fees and royalties from the sale of intellectual property. Breakthroughs in the Doha Round and new bilateral agreements in the pipeline can not be expected to even double intellectual property income or reduce the trade deficit by ten percent.

Simply, the trade deficit cannot be significantly reduced without curbing the U.S. appetite for imported goods, especially, petroleum, Chinese consumer goods and automobiles. In August, the deficits on these items were $24.3, 22.5 and 10.0 billion, respectively, and together totaled 99 percent of the total goods and services deficit.

Although the dollar has weakened against the euro and other western currencies, the U.S. trade deficit will not improve much, because petroleum, Chinese imports and autos are not much affected by these currency shifts.

Petroleum is priced in dollars. As the dollar declines against the euro and other currencies, manufacturers and consumers earning their incomes in those currencies bid up the international dollar price, pushing the U.S. trade deficit up, not down.

Imports from China will continue strong, because the Peoples Bank of China, each month, trades billions of yuan for dollars in international currency markets to keep the yuan undervalued against the dollar, and to ensure Chinese manufactures are cheap in U.S. stores.

Korea and several other Asian countries follow similar currency strategies. The Bank of Japan, by maintaining near zero interest rates, encourages the carry trade in yen and dollars, and this keeps the yen cheap against the dollar too.

Japan and Korea are major suppliers of non-North American automobiles and will continue to supply significant shares of the U.S. market from factories advantaged by cheap currencies.

Although a weaker dollar against the euro will boost U.S. exports a bit at the expense of European rivals, dysfunctional U.S. energy policies, currency manipulation by China, Japan and other nations, and other competitive advantages Asian automakers enjoy over U.S. rivals will keep the U.S. trade deficit from falling enough to remove its tax on U.S. GDP and incomes.

Neither the Doha Round nor pending U.S. bilateral agreements with Korea and other countries address the currency issue. The oil deficit and Detroit automakers other woes requires domestic solutions.

The United States is not going to export or negotiate and its way out of the trade deficit, and that has severe consequences for the long-term health of the U.S. economy.

Consequences for U.S. Debt, Incomes and Growth

To finance many years of trade deficits, Americans have borrowed more than $6 trillion, over and above foreign direct investment in U.S. productive assets, and the interest payments on that debt comes to about $300 billion in 2007. The United States continues to borrow more than $500 billion each year, and in 2008, the debt services will grow to nearly $350 billion.

Labor productivity is at least 50 percent higher in export and import-competing industries. The trade deficit, by shifting workers out of these industries into lower productivity activities and encouraging some adults to leave the labor force, is slicing about $250 billion a year off GDP.

Together, the debt service and lost GDP cost the U.S. economy about $550 billion a year, and that comes to about $1750 for each American worker.

Further, by cutting investments in R&D and labor skills, the trade deficit cuts potential annual economic growth from about 4 percent a year to about 3 percent. Were it not for the trade deficits of the last two decades, the U.S. economy would be 20 percent larger today.

Neither the Bush Administration, nor the Democratic leadership in Congress, nor the leading presidential candidates have endorsed policies that would significantly curtail U.S. dependence on imported oil, substantially reduce the surge of China imports, or improve the competitiveness of the U.S. Big Three automakers.

The recently concluded United Autoworkers - General Motors labor agreement will reduce but not eliminate domestic automakers fundamental labor cost disadvantages, and they will continue to lose market share. Auto industry, both among management and at UAW, is wholly disinclined to leveling with workers about what is needed to straighten out their beleaguered industry.

Policies are within our grasp that could resolve most of these problems. However, neither President Bush nor his likely successors seem willing to invest the necessary political capital to affect changes in domestic energy policy and commercial relations with China.

No one wants to get between the U.S. Big Three automakers and the UAW.

The trade deficit will remain too large, and it will continue to lower U.S. incomes and growth.

Economic Forecasts

Forecast Previous Period
October 12

Retail Sales - Sept 0.2%* 0.3
Retail Sales (ex autos) 0.3* -0.4
New Vehicles and Parts -0.1 2.8
*Revised

PPI - Sept 0.5% -1.4
Core PPI 0.1 0.2

Business Inventories - Aug 0.3%* 0.5
*Revised

Mich Cons Sentiment - Oct (p) 87.0 83.4

Week of October 15

October 16
Net Foreign Purchases - Aug $80.0b 19.2

Industrial Production - Sept 0.1% 0.2
Capacity Utilization - Sept 82.2% 82.2

NABH Index - Oct 21 20

October 17
CPI - Sept 0.2% -0.11
Core CPI 0.2 0.2

Real Earnings - Sept 0.1% 0.5

Housing Starts 1.290m 1.331m
Building Permits 1.310m 1.307m

October 18
Leading Indicators - Sept 0.2% -0.6

Initial Jobless Claims 312k 308

Week of October 22

October 25
Durable Goods - September 1.2% -4.99
Durable Goods Shipments 0.2 -1.6

Existing Homes Sales - Sept 5.20m 5.50m