The $39.5 billion U.S. trade deficit for the second quarter, plus the $15.7 billion deficit for June, could be the forerunner of bad trade numbers through the third quarter. Charles R. Taylor, international economist in Washington for Prudential-Bache Securities Inc., is of this opinion. He further believes that because of this succession of bad trade figures, the dollar will fall to 120 Japanese yen in the foreign exchange market by year-end. That's a 17 percent decline from today' 143 yen to the dollar level.
Taylor said that there are two ways to shrink our trade deficit. One is to have a weaker dollar. The other is to lower the rate of growth in our domestic demand to 2 or 3 percent below those of our trading partners. And this is what Taylor views as our current problem: Our domestic demand is too strong relative to our trading partners. Our demand is helping the economies of foreign nations as they export to meet our domestic needs.
Taylor thinks July's trade figure will be worse than June's. He believes that when the markets perceive that the trade picture for the third quarter is deteriorating, the dollar will begin its' slide toward the 120 level.
Taylor singled out the newly industrialized countries (NICs) as an example of nations that have rapidly increased their export trade with the United States. This group includes the Pacific Basin countries, Brazil and Mexico. Until recently, many of them had their currencies closely pegged to the dollar.
About 30 months ago, these nations were fiercely price competitive with the United States, with their unit cost of production being one-half of ours. Today, their unit costs are three-quarters of ours. This means that the NICs still have us totally beaten on costs and all that constrains their exports to the United States is their capacity to produce.
A year ago the trade figures showed that one-fourth of our trade deficit was with the nonoil producing less-developed countries (LDCs), while today they account for one-third of our trade deficit.
Consequently, Taylor feels that the NICs, with one-third of our trade deficit, have been impervious to the decline of the dollar to date. As a result, Taylor says the regular trade-weighted indexes are misleading because they do not take the NICs into consideration.
For example, the regular trade-weighted Federal Reserve index contains 10 industrialized countries and shows the dollar as having declined 40 percent since 1985. However, when the NICs are averaged in, that decline is only 25 percent. That's one big reason Taylor feels the dollar and the correction of our trade deficit still have a long way to go.
If you agree with Taylor's position, you could take advantage of his expected further decline in the dollar by investing in nondollar assets. One such investment would be the T. Rowe Price international bond fund, whose assets are denominated in foreign currencies. With a current return of 10 percent, investors will also benefit from the appreciation of those foreign currencies as the dollar declines. James E. Lebherz has 28 years' experience in fixed-income investments.