The nation’s trade deficit fell in January to $37.3 billion from a downwardly revised $39.9 billion in December. It did so, however, for the “wrong reason.”

We saw a bigger decline in imports, which dropped by $3.1 billion or 1.69% to $180.0 billion, than we did in exports, which fell by $0.5 billion or 0.35%, to $142.7 billion. It is the wrong reason because both imports and exports fell. We want to see an expansion in world trade, not a contraction.

With the dramatic increase in both imports and exports in China release yesterday (both up by more than 45% year over year), the relatively small declines do not mean that overall world trade is declining. We are, however, the biggest economy in the world, so contracting trade numbers here are not exactly a sign of robust health in the global economy. Still, any decline in the trade deficit will help strengthen GDP growth, regardless if its source is rising exports or falling imports.

Taking a longer-term picture, things are a bit better. While the trade deficit is slightly higher than it was a year ago ($39.9 billion), both imports (11.91%) and exports (15.17%) are significantly higher than they were then.

The biggest import decline came from autos and parts, which fell by $1.5 billion. This could have something to do with the problems that Toyota (TM) has been having, although Toyota does build lots of cars here as well as import them.

Oil Imports Slide a Bit

We also imported “just” $27.3 billion worth of oil, down from $28.2 billion December. The import price for oil tends to lag the spot price somewhat, and recently oil prices have been rising, so look for our oil import bill to rise again in February.

A year ago, oil prices were near their lows as the world economy was falling apart. As a result, our oil import bill was just $18.3 billion, so we are up 49.2%. We actually do export some oil, as it sometimes makes more sense to send Alaskan crude to Japan than it does to the West Coast, so the overall petroleum balance was $22.7 billion, down from $28.6 billion in December but up from 14.9 billion a year ago.

The graph below (from breaks down the history of the trade deficit into its oil and non-oil components. It shows the massive deterioration in the overall trade deficit from 1998 through late 2005, then a stabilization at a very high level of over $60 billion a  month that lasted until the wheels fell off the world economy in the second half of 2008.

However, the overall composition of the deficit changed greatly during that time while we were bumping along the bottom. Our non-oil deficit started to stabilize much earlier, in early 2004, and started to improve significantly in early 2007. That improvement was masked by a sharp deterioration in the oil deficit as oil prices skyrocketed, eventually hitting $147 per barrel in July of 2008.

The plunge in oil prices in the fall of 2008 allowed for a massive improvement in the overall trade deficit. However, since then, oil prices have rallied from the low $30’s to the low $80’s and with it the trade deficit, particularly the oil side of it, has started to deteriorate again.

The oil side of the deficit is a particularly intractable problem, since it is not helped by a weaker dollar. If the dollar weakens, the price of oil just tends to rise in reaction. To solve this problem, we need to move to non-oil energy sources. We simply do not have the domestic oil reserves anymore for “drill baby drill” to be an effective answer, at least with regards to oil.

Domestic Natural Gas Usage Should Increase

It would be a very effective answer if we could shift over to using more natural gas, where supplies are extremely abundant thanks to the new shale plays. On an BTU equivalent basis, natural gas is also dirt cheap, welling for the equivalent of less than $30 a barrel.

Natural gas-powered vehicles are a well-tested technology, and are in use around the world…why not here? Both Ford (F) and GM already make them, they just don’t sell them here. It would even be possible to have a “gas station” at home if you already have gas for cooking or heating.

Yes, there are some potential environmental problems with shale gas, most notably potential groundwater contamination. However, those potential problems are very small relative to the environmental disaster which is coal. Not only does coal produce about twice as much CO2 as gas per BTU, is also creates massive amounts of fly ash that are left in huge piles near power plants. Last year, one of the dams holding back fly ash broke in Tennessee and cause one of the largest environmental disasters ever in the lower 48 states.

Coal also spew all sorts of other very nasty stuff into the atmosphere, including mercury, lead and arsenic. Clean coal would be nice, but then again it would be nice to catch a leprechaun and get his pot of gold. That’s not going to happen because leprechauns don’t exist, and neither does “clean coal.” The administration’s infatuation with clean coal is just plain silly, or just something that helps keep Senators Rockefeller and Byrd happy.

Weaker Dollar Helps Non-Oil Side
A weaker dollar would help greatly on the non-oil side of the deficit, however. Prices of imported goods would become more expensive relative to domestically made goods. People might decide to buy more Fords and fewer Toyotas, or at least Toyota might decide to sell more cars  built in its plants here.

Our exports could be more competitive with the offerings of other nations, either the country we are selling to directly, and against other exporting countries’ offerings. For example, General Electric (GE) might have a better shot at selling electrical generators in India rather than the order going to Siemens (SI) of Germany.

The rebound in the dollar over the last few months (mostly in response to the “Greek drama”) works in the wrong direction. “King Dollar” is a tyrant who needs to be overthrown. Yes, sending King Dollar to the guillotine would cause inflation to be somewhat higher, but the problem the country faces right now is jobs and growth, not inflation, which is very much under control. Not only do the economic statistics tell you that, but the bond market is practically screaming it.

If inflation were about to zoom to 5 or 6% why would any person with an above room temperature IQ buy a 10 year T-note at 3.7%? If inflation were the problem, not unemployment, I would favor a stronger dollar, but that is not the case today.

Looking Ahead in China

By country, our biggest deficit by far is with China, where it expanded to $18.3 billion from $18.1 billion in December. This presents another problem for solving the trade deficit problem as long as China keeps pegging the Yuan to the dollar. If the dollar weakens, then so does the Yuan, and U.S. imports from China will not fall, and our exports to China will only benefit indirectly — to the extent we displace other countries exporting to China.

To bring the world economy back into balance, the Yuan must rise as the dollar falls. China does not have a big problem with growth right now, but it is starting to have a growing inflation problem, so it would be in the interest of the Chinese people to see the Yuan strengthen as well. I think it will eventually happen, but probably in a controlled way.

As it does, firms that are tied to the Chinese domestic economy should do very well. A large-cap beneficiary of this would be China Mobile (CHL), which gets almost all its revenues from within the Middle Kingdom, not from exports.

Another way to play this would be through the Claymore China Small-Cap ETF (HAO), since small-cap stocks in China tend to be more domestically focused than are the large caps.

Trade Deficits Elsewhere

Our deficit with OPEC rose to $7.2 billion from $6.8 billion in December. Meanwhile, the deficit with Mexico fell to $4.6 billion from $5.2 billion. Mexico’s oil production is drying up, and with it, its exports to the U.S.

Our deficit with Canada increased to $3.9 billion from $3.0 billion. Canada is by far our largest source of imported oil, not to mention our largest trading partner overall. The deficit with Japan fell to $3.3 billion from $4.6 billion. Toyota’s troubles might be part of the reason for that decline. The gap with the European Union also showed a sharp decline, falling to $2.8 billion from $6.4 billion in December.

Overall, a decline in the trade deficit is still a good thing. I just wish it were happening for the right reasons. The persistent trade deficits are what drives our external indebtedness, not our budget defits.

Dirk van Dijk, CFA is the Chief Equity Strategist for With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.

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