This week, we take another look at one of the economy’s spending categories: “net” exports, which are the difference between exports and imports of goods and services, income receipts and payments and net unilateral transfer payments.
A positive value for net exports would represent net positive spending in the U.S. economy, adding to GDP. A negative value for net exports represents a net loss to the U.S. economy and a subtraction from GDP. Net exports do not change dramatically from quarter to quarter.
Therefore, tracking the performance of net exports is more useful to explain medium to long-term performance in the economy rather than short run fluctuations.
The International Trade Report
Each month, the U.S. Census Bureau and the U.S. Bureau of Economic Analysis (www.bea.gov) release a report titled “U.S. International Trade in Goods and Services.” Although the reference month in the report is two months earlier, a moderate lag for economic data, the report does contain considerable detail on the trade balance by major category of goods and services as well as by country.
The data are reported in both current dollars and in seasonally adjusted dollars, as well as a three-month moving average.
As shown in the accompanying chart, net exports or the nation’s “trade balance” has been negative since the early 1990s. From 1992 to 1998 the trade balance showed a moderate worsening, but starting in January 1998 it increased dramatically from $10.7 billion to $34.4 billion in September 2000.
This growing deficit was associated with a surge in imports into the U.S. as a result of rapidly rising personal incomes and a rising stock market (the “wealth” effect).
Following the recession which began in March 2001, the trade deficit fell to $26.7 billion in December 2001 as consumers adjusted to lower net worth and an appreciating dollar raised import prices.
When the recession officially ended in November 2001, the trade deficit began to grow again — reaching a record level of $689 billion in October 2005.
Let us now explore two significant facts about this negative trade balance.
Negative Net Exports and GDP
Since negative net exports reduce GDP, there is an implicit argument that reducing imports would help reduce the deficit in the balance of trade. While this is partially true, at the extreme eliminating all imports would at the same time ultimately eliminate all exports. Importing provides the supply of dollars needed by foreigners to purchase our goods and services (exports). They demand dollars with which to purchase our goods and services.
If this supply of dollars dries up, the dollar would begin to appreciate in value making our exports more expensive and reducing exports. A policy designed to significantly reduce imports could result in an appreciating dollar that ultimately reduces our exports.
When a country is running a negative balance of trade, the implication is that there is a greater supply of dollars on the world’s markets than needed for our exports. The result would then be for a depreciating dollar, raising the price of imports and reducing the price of our exports, moving us toward a more favorable trade balance. But this process could have an impact on inflation by driving up the cost of imports.
Fortunately for the U.S., the extra dollars on the world’s markets created by a trade deficit are being absorbed by the demand for U.S. assets and U.S. government bonds. In effect, foreign governments and others are loaning us the money with which we are purchasing imported goods and services.
If these purchases by foreigners were not being made, import prices would rise and Americans would reduce imports.
Long-term impact of negative net exports
When a negative trade balance is financed by the purchase of U.S. assets, the “capital account” of the U.S. is affected. The capital account reflects the way in which the U.S. finances it deficit on current account (trade balance).
If the trade balance shows a $68.9-billion deficit (October 2005), then the capital account must show a change by that same amount. This occurs by noting an increase in the foreign holdings of U.S. assets (buildings, companies, stocks and bonds) has occurred.
This seems benign enough, and would be except for the fact that the trade deficit has been going on for some time with the result that foreigners own some $10.7 billion worth of U.S. assets, with 27% of these assets in U.S. government securities.
Although this number is large, is it a problem for the U.S. economy?
There is a great debate about the potential impact of a large external debt. It is a fact that no country can incur a growing external debt forever. At some point, the debt service on these obligations could consume a large portion of national income. But is it a problem now?
As long as the holders of this debt do not make a sudden and collective decision to “cash-in” these obligations, and as long as other foreigners are willing to increase their holdings of our assets, the debt is not an issue.
The question that arises, however, is at what point will the size of the debt held by foreigners become disconcerting for the holders of that debt who fear a sudden depreciation of the dollar and a consequent loss of value in their holdings?
While a sudden loss of confidence in the dollar seems remote, if it were to occur the dollar would devalue quickly, interest rates would be driven higher to attract others to U.S. debt instruments, and the economy would slow dramatically. There is really no way to tell where this point is, so it is not possible to gauge when the day of reckoning will occur.
What is certain is that external debt could become “too large” and such a day of reckoning would happen.
Dr. William D. Gunther is professor of economics and director of the Bureau of Business and Economic Research in the College of Business at the University of Southern Mississippi. Contact him via e-mail at firstname.lastname@example.org.
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