Trade Gap

Paul Blustein
Washington Post Staff Writer
Monday, November 21, 2005 12:00 PM

Washington Post staff writer Paul Blustein was online to discuss the vast trade gap between the U.S. and Asia and what that means for the global economy at Noon ET, Monday, Nov. 21 .

In recent stories Blustein wrote that in the United States, imports exceeded exports last year by $617.6 billion, a record gap equal to 5.3 percent of gross domestic product. The U.S. trade deficit , which swelled to $66.1 billion in September, has grown further in the first nine months of this year compared with the same period in 2004.

South Korea, by contrast, ran a $29.4 billion trade surplus last year, or 4.3 percent of its GDP, and even that paled by comparison with Japan's $132 billion surplus or the $100 billion-plus surplus China is expected to post this year.

The mountain of U.S. bonds that foreigners are accumulating means the United States is going deeper into debt to fund its import binge, to the tune of about $3 trillion as of this year.

A transcript follows.

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washingtonpost.com:

U.S. Trade Deficit Hangs In a Delicate Imbalance , Nov. 19, 2005.

As U.S. Trade Gap Grows, So Do Asian Banks' Foreign Reserves , Nov. 19, 2005.

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Paul Blustein: Hi everybody...Wow, I'm pleased to say that there are already quite a few comments and questions posted, most of which look very interesting, well-informed, and in some cases daunting. I'll do my best to answer as many as I can. Here goes...

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Newark, Del.: A $700 billion $ per year current account deficit sounds incredibly huge. How is this going to end?

Paul Blustein: This is a good question to start with, partly because you used the term "current account deficit," as did some of the other questioners, but other readers may not understand it. Without getting into a lot of details, the current account is the broadest way of measuring the trade deficit--it includes a few things that we don't normally think of as exports and imports, such as dividends and interest on overseas investments. We used the term "trade deficit" in Saturday's story because that's a term most people are familiar with, and fortunately these days the current account is very close in size to the trade deficit.

Now, on to the real meat of your question: how is this going to end? You can get almost as many answers to that question as you can find economists. Some think it will be a "hard landing"--a financial crisis in which foreign investors dump U.S. securities en masse. Some think it will be a "softer" landing, in which foreigners just gradually insist on higher rates on their U.S. investments. And some people think the landing will be softer still, with the dollar just gradually easing down and trade flows reversing over time.

I think it's impossible to predict which scenario we'll get, but I have to admit I find myself nodding my head when I hear economists say that the risks of a bad outcome are unacceptably high.

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Virginia: Good afternoon:

The trade deficit refers only to the current account, but not the capital account. If I'm not mistaken, basic economics teaches that the current account plus the capital account balances everything out. Nations don't trade with each other, people do.

Also, one could make the argument that there are states in the U.S. that run trade deficits with other states or that there are U.S. cities that have trade deficits with other U.S. cities, and yet nobody worries or cares.

So, why should one worry?

Paul Blustein: You're right to say that just because a country is running a trade deficit, or a budget deficit, or almost any other kind of deficit, that's not necessarily a reason to worry. There's no magic to having exports being exactly equal to imports, and no magic to having spending exactly equal to saving. Just like a company that borrows to finance the building of a profitable factory, there is no reason why governments and countries shouldn't borrow.

However, there are two important reasons why I think this sort of nonchalance isn't appropriate when it comes to the U.S. trade deficit. The first is that the U.S. has a very high consumption rate and rather low investment rate at the moment. That means that instead of investing the foreign inflows in ways that will give us higher living standards in the future (and provide us with productive capacity that will enable us to pay back our foreign creditors), we're consuming most of the money.

The second reason is the sheer size of the deficits, and the accumulated debt. As I mentioned in Saturday's story, the U.S. net debt (in very simple terms, our accumulated trade deficits) are now in the $3 trillion range and rising pretty fast. That could certainly start to worry foreign creditors at some point if they see little chance that it will be turned around.

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Washington, D.C.: Not a question--just a comment.

These two pieces were terrific! Easily the best description and explanation of the inter-relation of the trade and saving questions that I have seen anywhere! Congratulations!

Alice M. Rivlin

Paul Blustein: Well, I can't resist posting this--for those of you who don't know, Ms. Rivlin is a former vice chairman of the Federal Reserve. Thanks very much--I really tried in Saturday's story to find a human way of illustrating a concept that most people find very abstract and difficult to comprehend.

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Northville, Mich.: Why is it the U.S.A. deficit has gone so long uncheck that we now owe every country around the world boat loads of money. Is it that this administration is so corrupt and greedy it does not care?

Paul Blustein: Actually, I think some people in the administration care quite a bit about the problem. Not all--some think the problem is overblown, and some of their rhetoric has certainly reflected that. But in talking to people like Tim Adams, the undersecretary of the treasury for international affairs, I'm quite struck by the fact that he seems determined to take measures that will ameliorate the global imbalances. He sensibly argues that it should be done in a way that minimizes the risk of a severe blow to global growth, but he does believe steps must be taken.

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Rincn, Puerto Rico: During the time I lived in Japan during the mid to late 1980s there was hardly a day that went by without the US print and broadcast media loudly decrying the trade imbalance. Why has there been no similar response to our trade deficit with the PRC?

Paul Blustein: I well remember all the hue and cry about the trade imbalance with Japan, because I was based in Tokyo from 1990 to 1995. But I guess I disagree with the premise of your question, because there IS a big hue and cry about the trade deficit with China these days.

In general, I think it makes a lot more sense to look at the overall trade imbalance rather than the imbalance with individual countries. Take China as an example. One reason why the U.S. deficit with China is so big is related to the way trade works in Asia. Companies from countries like Japan, South Korea, Taiwan etc. send partially-finished products (computers, videocameras, sophisticated machinery etc.) to China for finishing--the labor-intensive work that Chinese workers do cheaper than just about anywhere else in the world. Then the goods get exported here. Those shipments get counted in our trade deficit with China rather than with the other Asian countries, but in a sense that's misleading. I hope I've explained why.

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Washington, D.C.: I can't really think of a more sophisticated way to ask this, but here goes, what exactly are the long-term implications of this record trade deficit, especially when you take in account the record spending that has occurred within the past few years as well. Do they both indicate that the financial health of this country is in serious peril or are the consequences of both problems completely unrelated?

Paul Blustein: I assume what you're asking is whether the trade deficit is related to the budget deficit. There's a lot of controversy about this, as you've probably noticed--you'll see editorials and op-eds on both sides of the issue.

The people who argue that there's no relationship often cite a piece of evidence that they argue should settle the argument. They point out that in the late 1990s, we had a budget surplus but we still had a large trade deficit.

That's true. But there's a pretty good counter-argument. One reason we had such a big trade deficit in the late 1990s was that we had a very high rate of investment--that, remember, was the period of the high-tech boom. We were drawing in a huge amount of money from overseas, and running big trade deficits (those two phenomena are inextricably linked), but the money was essentially flowing into all kinds of technological investments by companies.

Today that's not nearly so true. Some of the money is flowing into productive investment, but we have a much lower investment rate today than we did in the late 1990s. So in effect, a lot of the foreign money is going to fund our budget deficit--that is, the borrowing by our government. Another way of thinking about this is that the money is funding a high level of consumption.

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Rochester, N.Y.: What is the relationship between offshore outsourcing and the trade deficit? Does one have a causal effect on the other?

Paul Blustein: Certainly if a U.S. company outsources some of its production to, say, China or India, and exports the production to this country, that will have an impact on the trade deficit. And a lot of our imports--the number is in the neighborhood of one-third, last I looked--come from overseas plants owned by U.S. companies. So in that sense the two phenomena are related.

When you refer to outsourcing, though, I assume you're referring to the relatively recent phenomenon of, for example, computer software engineers being laid off and being replaced by engineers in Bangalore. Although obviously that's extremely painful for the Americans who lose their livelihoods, it is still a relatively modest phenomenon--compared to the huge size of overall trade flows, at least. So in that sense, I wouldn't say that outsourcing is particularly related to the trade deficit. Depends, though, on what you mean by outsourcing.

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Monroe Township, N.J.: Why is China willing to hold a large part of US debt? Can they use the debt aggressively against us?

Paul Blustein: Excellent question--as were the previous ones!

The Chinese are "willing" to hold our Treasury securities for one important reason--for the past decade or so, they have rigidly linked their currency, the yuan, to the U.S. dollar, at a rate of about 8.27 per dollar. Since Chinese companies are obviously very competitive, and are earning lots of dollars, that means the Chinese central bank has to "soak up" those dollars by trading yuan for them--otherwise, the yuan would surge in value. And once the Chinese central bank has dollars, pretty much the only thing it can do with them is invest them in U.S. securities.

Sorry if that seems complicated, and it obviously raises the related question of China's currency policy, which is a whole 'nother controversy!

As for the second part of your question, if you read Saturday's story, you may have noticed the sidebar where I quoted from a Foreign Affairs article by Nouriel Roubini and Brad Setser. They pointed out that the Chinese COULD use their vast holdings of Treasury securities against us, by threatening to dump them, in some sort of foreign policy confrontation. Of course, that would hurt the Chinese a lot--perhaps more than it would hurt us; it's hard to say. But one way of thinking about this is that it's a sort of "balance of mutual terror"--a term used by former Treasury Secretary Larry Summers. It's not a very healthy situation, in other words.

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Burke, Va.: In his recent book recent book "Three Billion New Capitalists" Clyde Prestowitz's argues that the trade deficit in combination with budget deficits and a debt-dependent economy will result in an "economic 9/11" where the dollar collapses and interest rates sky-rocket. What is your opinion of the liklihood of such a scenerio playing out? And, if so, what changes in policy would be necessary to avert these sequences of events?

Paul Blustein: Ah, now you're asking me a somewhat delicate question, because as a reporter I'm not supposed to make recommendations about what policies should be adopted to deal with the problems I've cited. That's what makes being a journalist so fun--you can carp and criticize, and sound alarms, without being responsible for producing solutions!

Having said that, I think there's pretty broad agreement among economists on both the right and left about what ought to be done. First of all, the U.S. needs to increase its savings--and since we've never succeeded at getting individual Americans to save more (though IRA's and so forth), that basically means reducing DISsaving. And the biggest dissaver of all is the U.S. government, through its budget deficit. Now, how you cut the budget deficit is something I am DEFINITELY not supposed to comment on.

Second, Asian countries need to raise the value of their currencies. If China un-pegged its yuan from the dollar and let the yuan rise, that would almost certainly cause other Asian currencies to rise too. Then Asians would have more purchasing power on world markets, and they would probably import more--that would also help to balance transpacific trade.

Third, Europe needs to take steps to increase its growth, so that Europeans would import more too. But Europe is a far smaller part of the global imbalance problem than is Asia.

You would find agreement with the above among economists affiliated with the Democratic party, Bush administration officials, IMF officials, and a wide variety of others who have looked at the issue. Not all economists agree, of course, but the consensus is pretty broad.

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Arlington, Va.: What does the phrase "hard landing" actually mean? What are the specific economic consequences that would occur? Presumably, if foreign lenders decide to stop lending, US interest rates will rise, but is that the only effect? Wouldn't the Fed loosen credit if that occurred, to smooth out the interest rate effects?

Paul Blustein: Another excellent question. One of the reasons why it's so tough to write about economics is that, in a story of 15 or 20 inches, it's impossible to explain all the possible ramifications and scenarios--and yet we know readers like this person are out there, contemplating all those ramifications and scenarios!

I suppose the best way to think about a hard landing is that we'll know it when we see it. If it materializes, it will probably be in a way that economists haven't even thought of yet.

But let me come to your specific question. Yes, the Fed could ease its grip on the money supply to try to mitigate the interest-rate effects of foreigners dumping U.S. securities. But remember, the Fed has to be sure that it doesn't allow inflation to get out of hand. If the markets worry that the Fed is creating too much money, that will only cause interest rates to rise even faster. So you could end up in an even more vicious cycle.

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Arlington, Va.: You wrote that it is "not a very healthy situation" that the potential for confrontation exists over China's lending to the United States. Why do you say that? It seems to me that an interlocking economic relationship that provides both parties with incentives to avoid serious conflict is a very good thing.

Paul Blustein: Fair point. The "mutually assured destruction" of the Cold War was, in a sense, highly desirable, because it gave both sides a disincentive to start a nuclear conflict.

Still, it isn't that hard to conjure up very nasty scenarios that would arise because of the large dollar holdings by central banks in countries such as China, Russia, Saudi Arabia etc. Here's just one: If foreign policy tensions with those countries really started to spiral out of control, the markets would start to worry that the central bank in question would start to dump dollars, and that alone could cause a panic to ensue. I'm not suggesting that this is a highly probable scenario, but I suspect it COULD be a constraint on U.S. policymakers.

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Arlington, Va.: Can you point to some examples from history where a large trade deficit led to a "hard landing"? What were the consequences?

Paul Blustein: In 1997, Thailand was running a current account deficit of about 8 percent of GDP. Remember what happened to the Thai baht? Of course, Thailand's current account deficit wasn't the only cause of the terrible crisis that ensued, but it played an important part.

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Washington, D.C.: At what point does our foreign borrowing become a currency-crisis? (Isn't this at aprx 5% borrowing compared to GDP?) If so, what are the new market opportunities?

Paul Blustein: Well, if 5 percent of GDP is the point at which we get the currency crisis, I'm afraid we're already past that benchmark.

It's worth pointing out that the United States can definitely afford to run bigger deficits, and accumulate more debt, than most countries such as the Thai case I just mentioned. One important reason is that the U.S. borrows in its own currency--that is, Treasury bonds are denominated in dollars. And the government has the power to create as many dollars as it wants. So the markets need never worry about a U.S. default.

Still, that doesn't mean the borrowing can go on forever, for the reasons I've tried to outline in both my story on Saturday and in previous answers above.

I'm afraid I've run on for too long--I really apologize to all those whose questions I was unable to answer. But I'm tremendously impressed by the quality of these questions, and I hugely appreciate your interest. Thanks very much!

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