Trade Deficit Slips on Oil - Analyst Blog

The trade deficit in July came in at $32.0 billion — a significant increase from the $27.5 billion in June. The consensus expectation was that it would be close to unchanged. Since the trade deficit is a direct input into GDP (net exports), this will moderately reduce the expected growth rate for the third quarter.

There was, however, some good news in the report: both imports and exports rose, imports just rose faster. Trade now seems to be in a sustainable uptrend, after falling off a cliff in the second half of last year and then stabilizing in the spring. This can be seen in the first graph below (from http://www.calculatedriskblog.com/).

A year ago, the trade deficit peaked at $64.9 billion on much higher levels of both imports and exports. The world-wide slowdown has dropped our exports by 22.4% from $164.4 billion to $127.6 billion this year, but our imports fell even faster to $159.6 billion from $229.3 billion, a drop of 30.4%. Overall trade and the trade deficit bottomed out in May, with a deficit of $26.4 billion, on exports of $122.2 billion and imports of $148.7 billion. An increase of 4.3% in our exports over the last two months is a good thing, but it is more than offset by 7.3% increase in out imports over the same time.

Much of the story on the trade deficit is really the story of oil prices. It was in July 2008 that oil prices peaked out at $147 a barrel, and then managed to plunge into the low thirties by December. We are sort of at a half-way point right now, with prices having more than doubled off the bottom but only half of what they were at the top.

The importance of oil to the trade deficit is highlighted in the second graph (also from http://www.calculatedriskblog.com/). The blue line shows the overall trade deficit, but then that is broken down to the oil deficit, in black, and everything else, shown in red. The vast bulk of the improvement over the last year has come from a lower oil bill. Unfortunately oil prices have been moving up (there is a bit of a lag between the oil prices discussed on CNBC every day and the import price, oil tankers are not exactly speedboats) from $39.22 in February to $62.24 in July, up for the fifth straight month.

However oil was not the whole story, either in the year-over-year improvement or in the more recent back-tracking. The lower overall level of demand as consumers pulled in their horns and attempted to save, or simply because they were laid off and had much less income, caused a lot fewer sales of the “made in China” and “made in Thailand” stuff that fills the aisles of Walmart (WMT) and Target (TGT).

The biggest deterioration in the trade deficit last month by type of good was actually in Autos, where imports rose by $2.4 billion in the month to $13.5 billion. This was because Toyota (TM) and Honda (HMC) were two of the biggest winners in the Cash for Clunkers program (although most of the cars they sold were made domestically, a lot were imported). The level of auto imports is still only 2/3 of what it was a year ago though. Industrial supplies — the category that includes oil — saw imports rise by $1.45 billion or 3.9% on the month, but are down $41.4 billion or 52% from a year ago.

Over the longer term, there is no way that we will be able to cure our chronic trade deficits unless we cure our addiction to foreign oil, or at least get it under control. I am a long-term bull on oil because the evidence is mounting that the world will have a hard time increasing its annual production of oil beyond what OPEC is currently holding in reserve due to the recession. Most major existing oil fields are seeing their production rates decline at 4% a year according to the International Energy Agency (IEA). The new deepwater finds off of Brazil and in the Gulf of Mexico are not going to be enough to offset this, let alone provide the incremental growth needed as billions of people in China and India move from bicycles to motorbikes to cars.

Relying on low oil prices to keep the trade deficit in check is a serious mistake. More use of newly abundant and cheap domestic Natural Gas would be a good stop-gap, and a major environmental improvement. Ultimately, though, we need much more efficiency, conservation and renewable energy sources. The time to get serious about it was years ago, but if we don’t get moving now, the long-term economic future of the country is bleak.