Wednesday, July 14, 2010

Latest Indicators Spell Trouble for US Economy

The US trade deficit widened to an 18-month high in May, catching many economists by surprise. The amount of money flowing out of the United States indicates that economic growth may be slowing. That's a bad sign for an already weak US economy.

According to the Commerce Department, the overall US trade gap for goods and services rose nearly five percent to $42.3 billion in May, from $40.3 billion in April.

Notably, the deficit cannot be blamed on oil imports, which sank 9.1 percent to $27.6 billion as both the price and the volume of oil shipments declined. Consequently, sales at gas stations also fell, down 2% as pump prices also declined.

Of greatest concern, perhaps, the trade deficit with China — the largest with any individual country — widened to $22.3 billion in May, from $19.3 billion in April. It was the biggest gap since last October.

However the trade data was mixed.

Imports climbed nearly three percent to a 19-month high of $194.5 billion in May, while exports also rose 2.4 percent to a 20-month high of $152.3 billion. So the good news is that exports are climbing, but they are being outpaced by imports.

Exports add to GDP, while imports reduce it. That's why it's critical for the US to increase exports and decrease its reliance on cheap consumer imports. Simply put, a trade deficit creates a drag on the economy.

In fact, the trade deficit may result in a 1-2 point reduction in economic growth for the second quarter. The US economy grew by 2.7 percent in the first quarter, but various indicators show the expansion may slow in the second half of the year.

China has undervalued the yuan in relation to the dollar to keep its products artificially inexpensive in the US while discouraging US exports into China, There are now concerns that the growing trade gap could create a wider rift between the two nations.

This controversial currency policy, which the Chinese central bank vowed to loosen just weeks ago, is contributing to high unemployment in the US. And it undermines President Obama's goal of doubling exports within five years to increase both jobs and growth.

But China is not the only obstacle to that goal.

The European debt crisis has slowed growth in Europe and raised the value of the dollar 14 percent this year versus the euro. As with China, a stronger dollar against the euro makes US goods costlier and less competitive in Europe.

The deficit with the European Union rose 7.5 percent to $6.2 billion as imports rose 3.2 percent, outpacing a 1.9 percent rise in U.S. exports to that region.

The upside to the rise in imports is that it indicates US consumers are spending once again. But given the state of unemployment, housing, consumer debt, and the state of the overall economy in general, this is a confounding development.

Consumer spending increased in four of the first five months this year (April was flat, but not declining). In fact, consumer spending rose at a 3 percent pace in the first quarter.

However, the data is contradictory.

Retail sales fell 1.1 percent from April to May, marking the first decline since September 2009. But, on a year-over-year basis, core retail sales were up 4.5 percent from May 2009.

And now we find that retail sales decreased 0.5% in June, further indication that the economy is slowing. Retail sales are a critical indicator because they account for about half of total consumer spending.

Two consecutive months of declines don't paint a portrait of confident, free-spending consumers.

In fact, the consumer confidence index plummeted to 52.9 in June — the lowest level since March — from a downwardly revised 62.7 in May. That's a huge drop. A reading above 90 indicates the economy is on solid footing; above 100 signals strong growth. By this measure, we are a long way from recovery.

And, rather suddenly, consumers are saving again. Cautious Americans saved more in May than at any time since September. According to the Commerce Department, the personal savings rate in May -- the part of every paycheck that goes unspent -- rose to 4 percent, the highest amount in nearly a year.

In this environment, it is not possible for US consumers to increase both savings and spending.

So the data is quite contradictory. No matter, American consumers simply won't rescue the US economy by purchasing foreign goods.

Given the challenges facing US consumers, it's hard to envision domestic consumption — which accounts for 70 percent of GDP — leading the US into economic recovery.

And given the expanding trade gap, it's also difficult to imagine exports leading the recovery either.

So what will? Your guess is as good as mine. But the numbers don't look good.

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