The Trade Deficit rose to $40.285 billion in April from $40.047 billion in March, and up sharply from $28.445 a year ago.
There were a few silver linings. First, the deficit was less than the $41.3 billion expected by the consensus of economists. Second, the March deficit was revised down from $40.42 billion.
Still, when one looks closely at the report, the numbers are not all that encouraging. For starters, it happened as both imports and exports fell. Since we are the most important trading nation on earth, if both our imports and exports are falling it indicates a slowdown in international trade.
To be sure a 0.68% drop in exports and a 0.41% decline in imports is not the sort of collapse we saw in reaction to the financial crisis in late 2008 that carried through to early 2009. But it is not an encouraging sign.
It was that collapse in trade that caused a huge improvement in the trade deficit a year ago. The overall collapse in trade, and its subsequent rebound, is clearly shown in the first graph below (from http://www.calculatedriskblog.com/).
Ironically, it was the collapse in trade — and the subsequent improvement in the trade deficit as our imports fell faster than our exports — that really kept the economy alive in the worst part of the Great Recession. For example, in the first quarter of 2009, when the economy was shrinking at a 6.4% annual rate, the drop in the trade deficit (and resulting improvement in net exports) actually added 2.64 points to growth. Put another way, without the drop in the trade deficit, the economy would have shrunk by 9.04% in the first quarter.
In the second quarter of 2009, the overall economy shrank 0.7%, but without the collapse in imports the economy would have fallen at a 2.35% rate. That, however, makes for some very tough comparisons on the year-over-year numbers (next month will be the toughest, and then the comparisons start to get easier).
While the decline in trade is relatively small, April saw the worst of both worlds — a higher deficit, and one caused by our exports falling more than our imports. As usual, our trade problems were centered on goods and we ran a surplus in services, but there was deterioration on both sides.
Our goods deficit increased by $100 million to $52.457 billion, while our service surplus fell by 1.38 million to $12.172 billion. Our total exports were $148.807 billion, a decline of $1.022 billion, with more than all of the decline coming on our exports of goods, which fell by $1.109 billion — slightly offset by an $86 million increase in exports of services.
Meanwhile our total imports fell by $784 million, with imports of goods falling by $1.009 billion and our imports of services increasing by $225 million. Relative to a year ago, our exports are up by $24.688 billion, or 19.9%, while our imports are up by $36.527 billion or 23.9%.
Granted, the year-ago levels were abnormally depressed, but it looks like we are on our way towards achieving President Obama’s goal of doubling our exports in five years. However, the big question is: So what? If we double our exports but also double our imports, our trade deficit will be substantially worse five years from now than it is today. While that would indicate robust growth in world trade, which would probably be a very good thing for world economic growth, it would substantially increase the rate at which America is going into debt to the rest of the world. It would be stomping on the accelerator pedal on the road to national bankruptcy.
The bulk of the problem is on the goods side of the equation. Of our total goods deficit of 52.457 billion, $23.920 billion (45.7%) was due to our petroleum deficit. The good news is that is actually down by $541 million from March, but relative to a year ago, it is up by $9.06 billion, or 61.3%.
Put another way, the increase in the petroleum deficit from a year ago is responsible for 76.5% of the $11.840 billion increase in the total trade deficit (both goods and services). Almost all of the decline in the month-to-month petroleum deficit was actually due to an increase in our energy exports (yes, we do export some; most notably it is sometimes more economical to ship Alaskan oil to Asia while we import from Canada, Mexico, Venezuela, etc.) rather than a decline in our energy imports. Stepping back and looking at the longer-term picture, our trade deficit excluding petroleum (red line) actually started to stabilize long before the overall trade deficit did.
This is shown in the second graph below (also from http://www.calculatedriskblog.com/). The overall trade deficit increased steadily and significantly from the late 1990’s until the middle of 2005, the non-petroleum side started to stabilize in early 2004, and actually had started to improve by late 2005. That improvement was masked by an ever-increasing oil bill as the price of crude relentlessly rose. It was not until the price of oil collapsed in response to the worldwide financial meltdown that the overall trade deficit started to shrink significantly.
However, as the world economy started to recover so did the price of oil, and once again our trade deficit has started to deteriorate. This does offer some hope on the trade picture going forward, as the trouble in Europe has caused oil prices to fall again, but nothing like the collapse in late 2008. That effect, though, is likely to be swamped by the loss of U.S. competitiveness on the non-petroleum side as the Dollar has soared and the Euro collapsed in recent months. Keep in mind that this data is for April, and thus is before most of the Greek Drama effects had time to hit, both in terms of the price of oil, and the strength in the Dollar.
The effect of changes in exchange rates often works with a bit of a lag, and the initial effect of a strengthening currency can actually be a decline in the trade deficit (it costs fewer dollars to buy the same quantity of stuff when the Dollar is worth more) but that effect is eventually swamped by the fact that people can get similar goods at cheaper prices from countries with weaker currencies.
For example, a Chinese hospital might have already ordered an MRI machine from General Electric (GE), and with the Dollar stronger, it will show up as being worth more. However, for the next machine the Chinese hospital wants to buy, they might discover that the Siemens (SI) product is just as good (or almost as good), but since the Euro is very weak, they can get the Siemens machine significantly cheaper in Yuan than it would cost to buy another GE machine. This is what economists refer to as the “J-curve.”
I tend to worry far more about the trade deficit than I do about the budget deficit. It is the trade deficit that is responsible for our increasing indebtedness to the rest of the world. For each dollar of the trade deficit, we either have to sell off an asset worth a dollar or go into debt for a dollar.
If one thinks of it in terms of selling assets, the picture becomes more clear. In April, we effectively sold off the equivalent of Medtronic (MDT) after we sold off the equivalent of Bristol Myers (BMY) in March. How much longer can we keep that up before we have nothing left?
Remember that every dollar that the trade deficit goes up, there is a dollar less of GDP. If we could eliminate the trade deficit, we would increase GDP by $483 billion at the April rate, or 3.3%.
The core of our deficit problem is our addiction of oil. That actually understates the problem in calling it an addiction, since we really need it to survive. It is kind of like saying a diabetic is addicted to insulin. The BP (BP) disaster in the Gulf really highlights that we cannot drill our way out of the problem. At best, domestic oil drilling can mitigate the problem, but clearly it has to be far more regulated and controlled to make sure that it is done safely than we have seen in the past. Having regulators that are not LITERALLY in bed with the industry they regulate would be a very good place to start…
The answer is sort of like telling the diabetic that he has to eat better and get a lot more exercise to control his diabetes. It is not an immediate cure, and no doctor would cut off the insulin right away just because the diabetic stopped shoving Snickers bars in his face and washing them down with bourbon. However, without those steps, the insulin is not going to do that much good.
We need a plan to reduce the total amount of oil we burn. That will require both becoming more efficient in our use of it, and higher CAFÉ standards are a good start. But it will also require using different forms of energy. Unfortunately there are not that many good alternatives out there in a liquid form.
Other Energy Options, Near-Term
Ethanol does not help that much, although it is politically popular — especially in the farm states, and given the structure of the constitution, people in farm states have a disproportionately large say in national policy through the Senate. The problem is that the energy inputs in making ethanol are almost as much as the energy output from ethanol (there is some gain but not much when talking about corn based ethanol, sugar cane-based ethanol like they have in Brazil has a much better energy return on energy invested, or EROEI).
Vehicles can be adapted to run on natural gas, and we have that in abundance on shore domestically. It will take some legislation to solve the chicken-and-the-egg problem of not enough refueling stations for natural gas, because there are not enough vehicles that run on it, and not enough vehicles that run on it because it is very hard to find a place to refuel. There is also a higher initial capital cost for natural gas-fueled vehicles, but that would probably come down if there was a mass market for natural gas-powered vehicles.
Another solution is to move to many more plug-in hybrid cars, and generate more of the electricity from renewable sources like wind and solar. That will require a lot more investment in the transmission grid since the best places to generate renewable power is usually far from the population centers where the power is needed the most. While renewable power is growing quickly, it is doing so from a very small base — and we need the rate to accelerate and for the growth to continue at very high rates for many years to make a significant dent in our overall energy needs.
However, the cost of not doing so will be eventual national bankruptcy. We simply cannot go on being the consumer of last resort for the rest of the world, especially of oil. Every nation in the world would like to be a net exporter these days, but unless we start setting up major trade routes to Mars, that is mathematically impossible.
We CAN continue to run bilateral trade deficits with specific countries forever, but they have to be offset by bilateral trade surpluses with other countries. This is similar to how your everyday life works. You run a major “trade surplus” with your employer, but then run a consistent “trade deficit” with the grocery store. If you spend more at the grocery store than you are getting in your paycheck, then you are either going into debt, or selling off assets (drawing down you savings account would essentially count as “selling” your bank deposits). That can happen for a little while, but not forever.
Balanced Trade a Necessity
The world needs more balanced trade, and one would have hoped that the big shock like the Great Recession would have caused at least some movement in that direction. That does not seem to be the case. China, Germany and Japan are all consistent net exporters, while the U.S. remains consistently a huge net importer. However, if China were to immediately move to eliminate its trade surplus, its economy would slow dramatically, since it is very dependent on exports.
The recent moves towards rising wages in China will help raise domestic demand there, which should help the situation. With the crash of the Euro, Germany is likely to become even more competitive and will probably see its trade surplus increase, not decrease. The Euro crash is not likely to help the European countries on the periphery — they really need to reduce their trade deficits significantly.
Greece, for example, mostly “exports” tourism (the market for ouzo and olive oil is not that big) and most of its tourists come from elsewhere in Europe. The relative price of a vacation on the island of Paros may have declined relative to the cost of a vacation on the island of Maui, but it has not fallen at all against the cost of a vacation in Paris or in the Black Forest, since they share a single currency.
Thus countries like Greece are going to have to go through an “internal devaluation.” That means that prices and wages are going to have to fall there, probably by about 20% for Greece to become competitive again. That is going to be an excruciatingly painful process that is likely to cause significant social unrest. The process is already going on in the Baltic countries (Latvia, Lithuania, Estonia) and it has not been fun for those people.
Spain, which is another country that will need to go through this internal devaluation, already has 20% unemployment. The severe budget cutbacks will slow the economies in those countries. The slower economies will then generate less in tax revenues. The lower tax revenues will push the budget deficits back up, requiring still more budget cuts and tax increases.
This means that the countries of Southern Europe are likely to see negative or at best flat economic growth, not just for a few more quarters, but for years and years to come. Germany is also on the austerity kick, and if it were to eliminate its trade surplus, it too would be in danger of falling back into a prolonged recession. They will want to see their trade surplus increase to offset the effects of tighter fiscal policy at home.
Trade Deficit Likely to Worsen
While the trade deficit in April was not as bad as feared, it is likely to get much worse in the months to come. The absolute level is an ongoing disaster for the U.S. economy, and one that will eventually lead to very serious problems if it is not addressed.
However, if we were to suddenly reduce our trade deficit it would inflict significant economic harm on the rest of the world. Still, it has to be done. The best place to start would be to have a better energy policy that moved towards the use of more domestic energy sources. Natural gas in the short to medium term, renewable sources like Wind and Solar in the longer term.
Nukes might have a place at the table, but first I would like to see the waste question fully addressed. In a world of terrorism, having large quantities of highly radioactive materials stored above ground at reactor sites seems like sheer insanity to me. While that waste could probably not be used to make a full warhead without significant reprocessing, it could very easily be used to make a dirty bomb.
The low hanging fruit of more conservation and efficiency needs to be plucked first. The fastest way to make that happen would be to raise the cost of oil, which would provide an incentive to the private sector to use less of it. Cap and trade is a roundabout and relatively inefficient way of doing that. A direct carbon tax, or perhaps a tariff on imported oil, would be much more straight forward, but the revenues raised from it would have to be offset with tax cuts elsewhere to prevent a major drag on the overall economy.
Perhaps the best way would be to use the funds to offset a cut in the payroll tax for Social Security, particularly the employer side for incremental new hires. That would be a big step towards encouraging private sector job creation — something that the economy needs now just as much as it needs to solve the intertwined problems of the trade deficit and excessive energy use.
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.
