Flow of imports drags down economic growth

By Howard Schneider and Ariana Eunjung Cha
Friday, August 27, 2010; 10:12 AM

The Commerce Department slashed its estimate for U.S. GDP growth in the second quarter from a 2.4 percent annual rate to 1.6 percent, confirming fears that economic growth has slowed to a crawl.

Although the numbers were grim, they were expected to have been worse. The growth rate topped calculations by economists who had forecast that the earlier estimate would be almost halved to an annualized rate of 1.4 percent.

Corporate investment in such big-ticket items as new machinery and computers drove a lot of the growth in the second quarter, but troubles in the nation's housing sector, unemployment and, especially, trade all were a drag.

The government said the trade deficit subtracted almost 3.4 percentage points from second-quarter GDP - the largest hit from trade in 63 years.

The trade deficit spiked an abrupt 16 percent in June from the largest surge in imports in 26 years. The unemployment rate remains stuck at 9.5 percent and first-time unemployment claims continue to remain at levels much higher than what's considered healthy for the economy. Sales of existing homes and new homes in July hit record lows.

The government report showed that companies reining in inventories also contributed to slower GDP growth. The Commerce Department said earlier this week that orders for durable goods rose a bare fraction of what experts had predicted.

Although the economy has grown for the past four quarters, the deceleration in growth has been rapid.

The 1.6 percent growth rate in the April-to-June quarter compares with a solid 3.7 percent in first quarter of this year and a breakneck rate of 5.7 percent in the final quarter of 2009.

Many economists expect the nation's GDP to continue at a similarly weak pace through the rest of the year and have expressed worry that we're headed toward another recession.

New York University economist Nouriel Roubini put the odds of a double-dip recession at 40 percent while Mark Zandi, the chief economist at Moody's, said his estimate is 33 percent.

Later Friday morning, Federal Reserve Chairman Ben Bernanke is scheduled to deliver a major policy speech at an economic symposium in Jackson Hole, Wyo., that will provide another perspective on the economy.

Investors are eagerly awaiting whether the Fed will take any additional action to prop up the economy. But with interest rates near zero and Congress preoccupied with mid-term elections, it's unclear what steps could be taken.

Goldman Sachs analyst Alec Phillips wrote in a research note that while "we expect monetary policy to do most of the lifting from here, there is a clear role for fiscal policy if lawmakers choose to use it."

Phillips said that the effect of the Obama administration's massive $862 billion stimulus has faded to "essentially neutral" in the current quarter. "The challenge for the administration and lawmakers returning to Washington over the next couple of weeks isn't just how to boost growth from here, it's how to avoid policy outcomes that slow it further," he said.

The June trade shortfall of almost $50 billion was the largest in 19 months. Analysts say it could be an anomaly, narrowing in coming months if a global economic recovery fuels heightened demand for U.S. exports.

But the spike does raise fresh concerns about whether some of the same factors that led to the economic crisis, including U.S. overconsumption, are beginning to reemerge. The yawning deficit may also prove frustrating for the Obama administration as it seeks to create jobs by boosting U.S. exports.

Companies at the center of the trade debate portray an economy still in transition from recession to growth. U.S. oil imports are up and businesses are restocking their shelves with consumer goods - signs of recovery. But the rebound in global economic activity has yet to benefit U.S. exports.

At U.S. firms with operations around the globe, executives say they're stoking production, but that increase often hasn't translated into more exports.

Officials at Cummins Inc., an Indiana-based maker of engines and power systems, say that business is booming in such places as China and India but that new orders for its equipment are being met largely at its factories abroad.

"Almost everything we sell in China is made in China, and those factories are at capacity right now," spokesman Mark Land said. "The strength in those markets helps us overall, but our manufacturing capacity creates a limited need to export."

A range of companies in other sectors considered important for U.S. trade offered other explanations for the recent increase in the deficit.

Export revenue for staple U.S. commodities, for instance, has been flat despite rising sales because prices are down. Products that require a long lead time before delivery, such as aircraft, are enjoying a surge in overseas orders, but it could be years before that revenue is recorded.

The United States typically enjoys a trade surplus in the sale of civilian aircraft but the figure fell sharply in the first half of 2010 compared with the year before - a hangover from the recession that won't work out of the system until perhaps 2012, said Boeing spokesman Tim Neale. Aircraft orders are increasing worldwide, he said, and the company is planning to expand several production lines - but not until next year.

"We have a backlog of $252 billion - firm orders just waiting to be built," he said.

At a basic level, trade deficits represent a loss of wealth for a country - money flowing abroad for goods and services produced elsewhere, supporting businesses and workers in other countries. The United States remains the world's largest exporter, and the planes, cars, equipment, food, services and other things it sells overseas accounts for hundreds of thousands of jobs at home.

But the U.S. imports even more, and the growing gap raises a number of sensitive political and economic issues for an economy struggling to regain momentum.

Some economists blame record trade deficits - and shortfalls in the broader current account - for the 2008 financial crisis as the country lived beyond its means. The deficit fell dramatically during the recession. But its return this year could amplify concern about U.S. overspending and dependence on imported oil, feed into political tension with China over its currency policies, and possibly undermine investor confidence in the dollar.

Overall, June imports topped $200 billion for the first time since the fall of 2008, while monthly exports fell to $150 billion, from $152 billion the month before.

Macroeconomic Advisers, a financial consulting firm, said its own analysis found that a June slowdown in the U.S. economy was the result of the trade deficit. The company said data indicate that imports will continue to rise - as they typically do after a recession - while exports are "trending sideways" said Ben Herzon, an economist with the firm.

It isn't the trade deficit alone that is undercutting economic growth or stoking talk of a double-dip recession. High unemployment, a drop in business inventory investment and a laggard housing market, among other things, are contributing.

But economists warn that countries cannot sustain ever-larger trade shortfalls, and the administration and the International Monetary Fund among others have been seeking ways for countries with persistent trade deficits to trim them.

The effort seems to be facing some stiff headwinds.

U.S. trade officials, for example, are betting that spending by foreign governments on roads, ports and other infrastructure will boost American companies. But it hasn't happened yet: The country's overall surplus in sales of capital goods fell from $13.4 billion in the first half of 2009 to $2.4 billion in the first half of 2010.

Exports of pharmaceuticals - another area U.S. officials point to as an export strength - have remained flat compared with a year ago, while imports have increased nearly 8 percent.

Still, the sharp jump in the June trade deficit might not be all negative.

"This may be business catching up to the fact that people ran down their inventories," said former IMF chief economist Mike Mussa, who is now a senior fellow at the Peterson Institute for International Economics. "It takes longer for stuff to arrive on the boat, so there may be a sudden surge [in imports] for a few months."

An increase in imports of industrial equipment and supplies, for example, might reflect business investment that lays the groundwork for future economic activity. For instance, a growth in imports of auto parts may presage an increase in U.S. auto production and ultimately exports.

"The trade deficit typically widens as the United States pulls itself out of a recession," and begins to import more oil, equipment and other goods, Francisco J. Sanchez, undersecretary of commerce for international trade, said in a written statement.

The debate over possible responses is a broad one - including calls for Obama to push more aggressively to open foreign markets, and suggestions by both labor and industry groups that the United States craft tax and other policies that more directly support American manufacturers. Some lawmakers on Capitol Hill have also targeted China's currency and other policies, alleging that they give that country's companies an unfair edge.

According to some analysts, economic data show the United States struggling to exploit some of its traditional advantages.

"We still think it is the 1950s and '60s and we are the dominant ones," said Frank Vargo, vice president for international affairs at the National Association of Manufacturers. "Everyone is pouring money into R&D. What we are facing is an increasingly technologically competent world."

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