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 Richmans' Trade and Taxes Blog

Will improved trade deficit of October be temporary?
Howard Richman, 12/12/2010

According to statistics released on Friday, U.S. trade numbers improved in October. The U.S. monthly trade deficit in goods and services (seasonally adjusted) improved from $45.6 billion in September to $38.7 billion in October as shown in the graph below:

About half of the trade deficit is our goods trade deficit with China. That bilateral trade deficit also improved, as shown in the graph below:

One reason for the improving U.S. trade deficit is that the U.S. economy is growing slower than its trading partners. The emerging market economies, including China, are growing especially rapidly at the moment, as shown in the graph below:

When a country grows slower than its trading partners, its exports tend to grow faster than its imports. That's because trading partners' demand for imports grows faster than American demand for imports. Indeed, the October statistics show U.S. exports growing, while U.S. imports stay flat.

Another possible explanation could be the exchange rate of the dollar, which was especially weak in October. When the dollar weakens, American products become more competitive in U.S. and world markets and foreign products tend to become more expensive in American markets. If this is the dominant factor, then the improved trade deficit may not continue. Since November 1 the dollar has strengthened from $1.39 to $1.32 per euro and from 80.4 yen to 83.7 yen per dollar.

The emerging market governments have been working especially hard to keep their products competitive through currency manipulation. As the following graph shows, most have been devoting more than 3% of their countries' GDPs, over the last year, to the manipulation of exchange rates:

Even Mexico and South Korea, countries that have or want free trade agreements with the U.S., have been manipulating exchange rates lately. These trading partners do so in order to increase their exports and reduce their imports. By doing so they increase our imports and reduce our exports. The United States government doesn't even object!

Which will win out? Will growing demand in the emerging market economies increase demand for American products, causing a continuing decline in the U.S. trade deficit and give us an export-led recovery? Or will growing currency manipulations by our trading partners prevent us from having much of a recovery at all?

One thing, for sure, the Chinese government does not intend to increase imports from the United States long-term. It is rapidly moving forward at the moment with government-production of commercial aircraft so that it won't have to permit aircraft imports from Boeing or Airbus. China is following the mercantilist strategy of maximizing exports while minimizing imports in order to grow in political power while bringing down the power of its trading partners.

Comment by Martin Davies, 12/14/2010:

Thankyou, Howard