The Economy's Rebalancing Act

By Robert J. Samuelson
Wednesday, December 20, 2006

Consider it a good omen. In October the U.S. trade deficit dropped unexpectedly to $58.9 billion, about $5.4 billion less than in September. Although the largest cause was lower oil prices, strong American exports -- up 14 percent from a year earlier -- also contributed significantly. And that's exactly what the economy needs in 2007: an export surge. It would ward off recession and narrow today's dangerously large global trade imbalances. We need what economists call a "rebalancing" of our economy and the world's.

With unemployment at 4.5 percent, the U.S. economy is hardly ailing. But three threats cloud the outlook.

First, the real estate bust. Speculation helped fuel the boom -- and now it's payback time. In the past year, housing starts have dropped 27 percent and sales of new homes 25 percent. With buyers waiting to see how low prices go, inventories of unsold new homes have risen 14 percent. Some economists see recession. Falling home prices could weaken consumer confidence and spending. By year-end 2007, unemployment will hit 6.3 percent, predicts Dean Baker of the Center for Economic and Policy Research.

Second, turmoil in the auto industry. Unpopular models, steep gas prices and high labor costs have forced huge cutbacks at Ford, General Motors and Chrysler. Pressures could intensify. Total U.S. vehicle sales will decrease to 16.1 million units in 2007 -- the lowest since 1998 -- forecasts Moody's Economy.com. That would be down from 16.5 million in 2006 and almost 17 million in 2005. Since June, manufacturing jobs have dropped by 95,000; about 90 percent of the loss relates to autos and home building (lumber, furniture).

Finally, and most important, skewed trade. America has gorged on imports while other countries have become overly dependent on exports. In 2006 the United States will run a current account deficit of $878 billion, estimates the Organization for Economic Cooperation and Development (OECD). Meanwhile, China, Japan and Germany will record surpluses of $211 billion, $165 billion and $117 billion, respectively. (The "current account" is an expanded trade balance.) These huge imbalances could destabilize the world economy through a currency crisis or trade slump.

Although most economists think the Federal Reserve will engineer a "soft landing" -- nudging inflation down while avoiding a recession -- it may be a close call. The real question is whether the world moves toward a sturdier pattern of economic growth: stronger exports for the United States, stronger consumer spending elsewhere. The present pattern looks increasingly shaky because it involves a perilous contradiction -- other countries like selling to America, but they may choke on the resulting flood tide of dollars.

Until now foreigners have reinvested most dollars in the United States. In the year ending in September, they bought about $1 trillion worth of U.S. stocks and government and corporate bonds, says David Wyss of Standard & Poor's. Private investors -- not governments -- made 85 percent of those purchases, he says. But if the preference for dollar investments subsides, U.S. stock and bond markets could weaken. The dollar might drop sharply against other currencies. The U.S. economy could suffer from a loss of wealth and confidence; foreign economies could suffer from a loss of exports.

That's the danger of today's trade patterns. In time these will change. Even without India and China, developing countries are growing at about 5 percent annually. They will buy more machinery, aircraft and advanced instruments -- the heart of U.S. exports. With growing middle classes, these countries will also probably focus more on their own consumers in the future; dependence on exports to the United States will decline. In 2000, developing countries had a total of 352 million people in households with incomes over $16,000, the World Bank estimates; by 2030 that's projected to be 2.1 billion.

But next year is more iffy. Japan and China still seem wedded to export-led growth. A brighter spot is Europe, where domestic growth is accelerating. From 2001 to 2005, annual growth in the euro zone (the 12 countries using the euro) averaged only 1.4 percent. Now the OECD forecasts 2.2 percent in 2007 after 2.6 percent in 2006 -- and that may go higher. "In Germany," says Jean-Philippe Cotis, the OECD's chief economist, "people were scared to death about unemployment." If a falling jobless rate quiets their fears, they may spend more. That would be good news if it helps shrink those yawning trade imbalances.


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