The U.S. Trade Deficit, China and the Need to Rebalance Growth

The latest U.S. trade figures contain some good news for the U.S., in the short term at least. In 2010, the U.S. trade deficit was $497.8 billion, which is up from $374.9 billion in 2009 but still almost 30 percent below the 2008 trade deficit of $698.8 billion. The 2010 trade balance comprised a trade in goods deficit of $646.5 billion and a trade in services surplus of $148.7 billion. While exports of goods were up $222.1 billion over 2009, imports were up $352.4 billion. Exports of services were also up $40.5 billion in 2010 compared to the increase in services imports of $23.8 billion.

If we look more closely at the U.S. import figures, we see that in 2010 imports of capital goods and industrial goods (excluding oil) were up almost 25 percent from the previous year, from approximately $643 billion in 2009 to almost $800 billion. Moreover, imports of consumer goods also increased, but relatively less, from $428.4 billion in 2009 to $483.3 billion in 2010.

Where is the good news? First, the trade deficit is evidence of growing U.S. and global demand. The composition of U.S. imports also points to growth being driven by investment, which should flow through to output and jobs. The increase in consumption of consumer goods is also good for the U.S. economy, as it demonstrates growing consumer confidence which should in turn give businesses the confidence to invest and create new jobs.

The growth in U.S. exports is similarly good news. The 20 percent increase in exports in 2010 occurred across a range of sectors, including hi-tech goods, automotives and agriculture products. This demonstrates growing overseas demand for export-orientated industries, which should improve the growth and jobs prospects in these sectors. This is also important for Obama’s goal of doubling U.S. exports by 2015.

From a macroeconomic perspective, the U.S. trade deficit is a function of the gap between national savings and investment. As U.S. savings have been unable to fund investment needs, capital from overseas has been needed, causing capital account surpluses and corresponding current account deficits. While this savings-investment imbalance remains, the U.S. will continue to run current account deficits.
Since 2000, the shortfall in U.S. savings has become increasingly driven by the need to finance U.S. budget deficits. The U.S. budget went from a surplus in 2000 of 2.4 percent of GDP to a deficit in 2003 of 3.3 percent, and the Congressional Budget Office has predicted that the budget deficit will reach 9.8 percent of GDP in 2011. The need to fund budget deficits from national savings has contributed to the trade deficits.

These trade figures also demonstrate the significance of the U.S.-China trading relationship. In 2010, the U.S.-China trade deficit increased to over $273 billion, the highest bilateral trade deficit on record. It represents almost 55 percent of the total U.S. trade deficit.
The U.S.-China trade deficit is linked to the undervaluation of the Renmimbi (RMB), which is a result of it being pegged to the U.S. dollar. Like all cheap assets, the RMB’s undervaluation has led to excess demand for Chinese goods (in the form of imports), and for the RMB to pay for these goods. To meet this demand for the RMB and to maintain the peg, the Chinese government has had to supply more of its currency by purchasing low yielding U.S. Treasury bonds. China currently holds almost $900 billion in US Treasury securities.

The peg has had a range of consequences for the Chinese economy. One of these has been an over allocation of resources to China’s export industry and a corresponding lack of investment and development of its non-tradable sectors, in particular its services sector. It has also reduced the Chinese government’s control over its monetary policy because increases in its interest rates would only increase demand for the RMB, forcing China to supply even more RMB to maintain the peg with the dollar. The need to supply RMB to maintain the peg has also contributed to inflationary pressures in China, which is pushing 5 percent.

At the G-20 Summit in Seoul in November, members pledged to “undertake policies to support private savings and where appropriate, undertake fiscal consolidation while maintaining open markets and strengthening export sectors. Members with sustained, significant external surpluses pledge[d] to strengthen domestic sources of growth”. Consistent with this agreement, a rebalancing of Chinese growth toward domestic consumption, combined with movement toward a freely floating RMB and liberalization of its capital account, should lead to a rebalancing of the Chinese economy that could increase demand for U.S. exports and reduce the need for the China to purchase U.S. debt. This would in turn reduce the U.S.-China trade deficit.

A rebalancing only of the Chinese economy, however, will not be enough to address the U.S. trade deficit. Without a corresponding rebalancing over time of the U.S. economy toward less consumption and more savings, we can expect to see continuing U.S. trade deficits.