February 18, 2000 (Trade Byte)
Trade Deficit Approaches Record Levels
February 18, 2000
By Dean Baker
A $25.5 billion trade deficit in December pushed the 1999 deficit to $271.3 billion. Measured in dollar terms, this is a huge increase from the previous record of $164.3 billion set in 1998. Measured as a share of GDP, which is the proper basis of comparison, the 1999 deficit did not quite reach the record levels set in the mid-eighties. The 1999 deficit was just slightly over 2.9 percent of GDP. By comparison the deficits in 1986 and 1987 were both approximately 3.0 percent of GDP.
Still, the latest trade numbers do provide grounds for concern about the future. The deficit continued to expand rapidly over the course of 1999, so that by the fourth quarter, the deficit was equal to 3.3 percent of GDP. Imports are still rising at a more rapid rate than exports. Imports rose at 15.8 percent annual rate over the last quarter, while exports have increased by just 12.4 percent. This implies that the trade deficit is likely to grow further in coming months.
As long as growth in the United States continues to exceed that of most of the nation's major trading partners, the trade deficit is likely to continue to increase, until there is a major adjustment in currency values. With the European nations and Canada expected to grow at best at the same pace as the United States, and Japan and Latin America fighting off recessions, there is little prospect that differences in growth rates will improve the trade balance for the United States any time in the near future.
The situation on the current account is somewhat worse, as the massive foreign borrowing of recent years has led to a considerable accumulation of debt. The United States is now experiencing a small but rapidly growing annual deficit on investment income, as interest payments to foreigners exceed foreign payments to U.S. nationals and corporations. By contrast, in the mid-eighties the net investment income of the United States was still close to 0.5 percent of GDP on an annual basis. As a result of this increase in indebtedness, the current account deficit for 1999 is likely to slightly exceed the record 3.6 percent share of GDP hit in 1987. The latest projections from the OECD show the United States current account deficit rising to 4.2 percent of GDP for both 2000 and 2001.
Trade and current account deficits of this magnitude cannot be long sustained. If the trade deficit of the United States were to remain constant as a share of GDP at its fourth quarter level, and the Congressional Budget Office's GDP growth projections for the decade prove accurate, the ratio of foreign debt to GDP will be close to 60 percent by 2010. This is approximately twice as high as the highest level of foreign indebtedness among any major industrialized nation at present.
Rather than seeing this sort of run-up in indebtedness, it is more likely that dollar will decline significantly against other major currencies. In the late eighties, a decline of approximately 25 percent in the real value of the dollar was needed to bring the trade deficit down to a more manageable level. It is reasonable to expect that a decline of comparable magnitude would be required under current circumstances.
While the U.S. economy can surely manage this sort of adjustment, it will carry some costs. At present, the value of imports is equal to approximately 14 percent of GDP. By contrast, in 1987 imports were equal to 10.8 percent of GDP. If the higher import prices associated with the falling dollar were fully passed on to consumers, it would imply a 3.5 percentage point rise in the rate of inflation. More plausibly, if half the price increase were passed along, it would lead to a 1.8 percentage point rise in the rate of inflation. In principle, an acceleration of inflation of this size could be tolerated, but if the Federal Reserve Board remains determined to keep inflation at very low levels, the adjustment in the dollar could be associated with a severe recession.