In March, the Trade Deficit rose to $40.42 billion from $39.43 billion in February, and increase of 3.04%. A year ago, the trade deficit was $28.74 billion, so it is up a whopping 43.74% from then.
It is still, however, well below the $60+ billion trade deficits that were the norm before world trade imploded in the wake of the 2008 financial meltdown. The historic high in the Trade Deficit was hit in July 2008 at $64.9 billion, and by February 2009 if had plunged to just $25.50 billion.
That would have been great news if it had happened the right way, by exports rising faster than imports. However, that was not the case — both imports and exports plunged, which signaled the absolute collapse in world trade, which was both a cause and an effect of the world-wide Great Recession.
In GDP accounting terms it was very good news; without the drop in the trade deficit, GDP would have contracted by over 9% in the first quarter of 2009, rather than at “only” 6.4%. In the real world, it was just a reflection of the world in economic turmoil.
The good news is that world trade has recovered, and continues to do so. In March, imports rose 3.04% from February while exports were up 3.23%. Even though the percentage increase in exports was higher than for imports, the trade deficit rose because the base is so much bigger for imports. In March, we bought $1.27 worth of stuff (or services) from overseas for every dollar of stuff we sold. A year ago that figure was $1.23. The dramatic plunge and the ongoing rebound in both imports and exports can clearly be seen in the first graph below (from http://www.calculatedriskblog.com/).
The increase in the Trade Deficit was not all about China, either. While our Trade Deficit with the Middle Kingdom rose to $16.9 billion from $16.5 billion in February, as a share of the total trade deficit it held steady at 41.8%. We recorded big increases in our bilateral trade deficits with just about every major trading partner with the exception of Canada (which is still our largest trading partner).
Our deficit with the European Union rose to $7.1 billion from $5.3 billion, while our deficit with OPEC soared to $9.1 billion from $6.4 billion in February. With Mexico it rose to $6.0 billion from $4.8 billion, while Japan sold us $5.3 billion more worth of stuff than we sold them in March, up from $4.3 billion in February. Our deficit with Canada fell to $2.3 billion from $2.8 billion.
Obviously, those increases in the bilateral deficits add up to much more than the $1 billion increase in the total trade deficit, but the report did not indicate were we might have rising bilateral surpluses or falling deficits.
Since China keeps the Yuan pegged to the dollar, changes in the exchange rate are not going to affect our bilateral deficit with China, except indirectly. The rise of the dollar is going to make it that much harder for General Electric (GE) to beat out Siemens (SI) of Germany for export orders to China. It will not, however, make the stuff that fills the shelves of Wal-Mart (WMT) any cheaper. Then again, it will make French wines cheaper and could allow the French to take market share here from California growers.
When talking about the Trade Deficit it is mostly about stuff (goods) and not services. We actually run a surplus in services of $12.50 billion in March, up from $11.67 billion in February (up 7.1%) and $10.39 billion a year ago (up 20.3%). Even though services is a much bigger part of the economy than manufacturing (and when talking world trade you are really talking about manufacturing when talking about goods, unlike some other economic numbers where goods producing also includes construction), it is a much smaller part of the trade picture.
Service exports were jut 30.3% of total exports in March, and service imports were just 17.3% of total imports. After all, there are big parts of the service economy that are just not conducive to international trade. How, for example, can you import or export a haircut?
The Oil Factor
Our deficit in goods rose to $52.91 billion in March from $51.10 billion in February and $39.21 billion a year ago, increases of 3.5% and 32.9%, respectively. The reason for our surging deficit in goods really comes down to one word: OIL. Our deficit in petroleum products is almost half of the deficit in goods, and 61.4% of the total trade deficit, and as is shown in the graph below (also from http://www.calculatedriskblog.com/), is a major swing factor in the overall trade deficit.
Our non-oil deficit actually started to stabilize in the spring of 2004 and improved significantly by early 2007, but surging oil prices kept the overall deficit increasing rapidly until late 2005, and it did not start to decline until oil prices started to crash in the summer of 2008.
The non-petroleum deficit actually fell slightly to $26.6 billion from $26.9 billion in February due to the increased surplus in services. That is a decline of 1.08% on the month and is up 14.98% from a year ago. By comparison, the petroleum deficit was up 7.83% on the month and a staggering 70.45% year over year. The increase in the petroleum deficit was more than the total increase in the trade deficit for the month, and accounts for 83.3% of the increase in the total trade deficit year over year.
In other words, unless we are able to end our “addiction to oil” it will be extremely difficult for us to solve the problem we have with the trade deficit. Make no mistake, it is a problem and a very big problem. It is entirely the cause of our being deeply indebted to the rest of the world. The budget deficit contributes to that indebtedness only indirectly and through the trade deficit.
That, folks, is not a subject for debate — it is an accounting identity that can no more be violated than can Newton’s laws of thermodynamics. Ultimately it is a cancer eating away at our prosperity, our power and our prestige with the rest of the world.
As recent events in the Gulf of Mexico have shown, we are not in any position to end our oil imports by increasing domestic drilling for oil. Even if we were to ignore the environmental costs and go full bore into offshore drilling, the reserves simply are not there.
The overall trade deficit is likely to get worse in coming months due to the recent rebound in the dollar (thank you, Greece), which will make our exports more expensive overseas, and our non-oil imports cheaper, thus making them more likely to displace domestic products. On the other hand, oil prices have fallen back during the Greek Drama.
I would not expect that to last. Old oil fields are depleting rapidly, and the peak year for discovering new oil in the world was all the way back in 1964, and each successive decade has seen less and less new oil found. Combine that with surging demand, not only from China and India, but from the oil exporting countries themselves, and it is going to be very hard for the oil industry to keep up with demand.
Furthermore, what new oil that is being found is being found in increasingly difficult and expensive places, like under a mile of ocean before you even start to go two or three miles into the seabed. Ultimately, I think that offshore oil drilling will resume in the Gulf of Mexico, even despite the disaster jointly caused by BP (BP), Transocean (RIG) and Halliburton (HAL). (None of which was willing to take responsibility for their actions, and all pointed the finger at the others in yesterday’s Congressional hearings.)
The industry, though, is going to have to submit to much tougher regulation. The trade deficit problem is simply too big not to drill in the Gulf.
The Shift to Alternative Sources
Over the long haul, we are going to have to shift to alternative sources of energy, but it is going to take a very long time before wind and solar become large parts of the energy mix, even if they grow at exponential rates (and public policy needs to do much more to encourage that growth). Fortunately, there is a very good bridge between here and there. We have very large and growth supplies of natural gas, mostly due to the new shale plays that have opened up.
There is also a lot of natural gas out in the Gulf. If the well that the Deepwater Horizon was drilling were entirely a natural gas well (most wells will contain a mixture of oil, natural gas and a liquid form or natural gas called condensate), there would not be a huge slick headed for the beaches, but rather just a spot in the ocean that looked like a big Jacuzzi. While there are some potential adverse environmental effects from drilling in the shale plays, natural gas also has huge environmental benefits. Per unit of energy (BTU), it produces far less CO2 than does oil or — especially — coal.
It is not a huge technological leap to use natural gas as a transportation fuel, as it is used in cars in trucks in many countries around the world today. There is a bit of a chicken and egg problem of not enough refueling locations for natural gas vehicles, and service stations don’t want to put them in because there are not a lot of natural gas-powered vehicles on the road.
On the other hand, it is not hard to imagine a situation where people could refuel their vehicles at home. After all, most homes already have natural gas being piped to them for heating. Building safe and affordable compressors would be the major technological problem on that side, which does not strike me as insurmountable.
The cost of the vehicles would be higher, at least initially. But as prices stand now, on a per BTU basis, natural gas is the equivalent of oil at $25.38 a barrel. Over time that would defray a lot of the higher capital cost of the vehicles.
In Summation
Overall, the increase in the trade deficit was largely expected, so it is not going to have a big impact on the market. The rise in the deficit is bad news, but at least it is happening for the right reason — with imports rising faster than exports — rather than from both plunging.
Over time, the trade deficit is very bad news. We can simply not be the consumer of last resort for the rest of the world forever. That $40.4 billion deficit means that we have transferred $40.4 billion of our assets abroad in a single month. While most of that is in the form of Treasury notes, it is the equivalent of selling off Eli Lilly (LLY) this month, and then selling off all of Colgate-Palmolive (CL) next month.
The core problem is energy. We need to use what we burn far more efficiently, and have to transition quickly away from oil as our primary source for it. In the long run that means going to wind and solar, and perhaps more use of nukes (please solve the waste disposal problem first; in an age of terrorism, having large quantities of radioactive waste sitting around above ground and generally poorly guarded is just plain nuts).
In the short term, and as a long term supplement (for example, on calm or cloudy days) natural gas is a viable solution. We do, however, have to start to act with a sense of urgency.
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. 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.
