Even if the U.S. government somehow managed to balance its massive budget deficit, it would still have a huge trade deficit to grapple with. And that trade deficit may be an even tougher problem to solve.
For decades, the U.S. has consumed more than it has produced, imported more than it has exported, and borrowed more than it has saved. The trade deficit is the unfortunate result of all that imbalance. And then there's the problem of China's suppression of its currency, the yuan, which makes a bad situation even worse.
The U.S. trade deficit rose to $558 billion last year, up 11.6 percent from 2010 and the largest imbalance since 2008. As demand fell during the Great Recession, imports also fell, trimming the trade deficit. But the deficit has once again resumed its upward trajectory, which is bad news for the U.S.
Exports add to GDP, while imports reduce it. That's why it's critical for the U.S. to increase exports and decrease its reliance on cheap consumer imports. Simply put, a trade deficit creates a drag on the economy.
Though U.S. exports have increased over the past couple of years, the problem is that imports continue to outpace exports. This means that billions of dollars continue to flow out of the United States on a monthly basis. And the problem is worsening.
The U.S. current account trade deficit grew to its widest imbalance in three years during the first quarter, jumping 15.7 percent to $137.3 billion. That was up from $118.7 billion in the final three months of last year, according to the Commerce Department.
The current account is the broadest measure of trade. It tracks the sale of merchandise and services between nations as well as investment flows. Economists expect the deficit to keep rising in 2012 due to the European debt crisis, which will result in a decline of U.S. exports to the region.
The flood of imports into the U.S. is displacing American workers and costing us jobs. In short, we're buying tons of foreign goods instead of making them here at home.
According to a 2011 Economic Policy Institute report, the growth in the U.S. trade deficit with China displaced 2.8 million U.S. jobs between 2001 and 2010 alone.
The U.S. had a particularly massive (and record) $295.5 billion trade deficit with China in 2011, its largest with any individual country. This means that China accounted for more than half (53 percent) of the total U.S. trade deficit.
The Chinese currency, the yuan, has long been artificially suppressed by the Chinese government, keeping it from rising to a higher natural value.
China has undervalued the yuan in relation to the dollar for years to keep its products artificially inexpensive in the U.S., while discouraging U.S. exports into China.
This controversial currency policy is contributing to high unemployment in the U.S. A stronger dollar in relation to the yuan makes U.S. goods costlier and less competitive in China, undermining U.S. exports.
For the trade deficit to become more balanced, the Chinese must end the yuan's dollar peg. Short of that, Americans will have to save more and spend less, while the Chinese will have to do exactly the opposite. That combination appears highly unlikely in the foreseeable future.
A Chinese currency revaluation would raise the cost of Chinese goods sold by U.S. retailers to U.S. consumers. Higher prices would be a shock to millions of Walmart shoppers. But that would ultimately be a good thing for the U.S. economy.
The U.S. hands the Chinese billions of dollars every month in exchange for its cheap products. The Chinese are then forced to buy our Treasury debt with all those green backs. In essence, they are involuntarily compelled to lend us their excess dollar reserves. After all, what good are dollars to the Chinese? They don't use them in China.
Though the Chinese can purchase oil and other dollar-denominated assets on global markets, they are still left with a huge surplus of dollars.
Even with Treasury rates at historically low yields, the Chinese have little choice but to continue buying U.S. debt. That makes China's trade surplus with the U.S. a double-edged sword.
At current historically-low yields, Treasuries don't even keep up with the rate of inflation. Combined with the fact that the U.S. is so interminably in debt, Treasuries cannot possibly look like a smart buy to the Chinese.
China is already saturated with U.S. debt, which doubled between 2007 and 2010. In fact, in September 2008 China surpassed Japan to become the number one holder of U.S. government debt. Consequently, the Chinese previously signaled that they will begin reducing some of their U.S. holdings.
However, quite the opposite has happened. China's U.S. Treasury holdings increased $1.5 billion in April, rising to $1.15 trillion in total. China now holds one-quarter of all outstanding U.S. debt.
Last year, it was discovered that China was buying more U.S. debt than it was disclosing. It is now known that beginning in 2009, China was regularly doing deals that had the effect of hiding billions of dollars of purchases in each Treasury auction.
Where else is China going to put all those billions of export dollars each and every month?
As long as the Chinese continue flooding the U.S. market with exports, their only alternative to Treasuries would be the purchase of hard U.S. assets, such as land, golf courses, resorts and huge commercial properties — the sort of thing that Japan was doing in the 1980s.
That would surely set off quite the political firestorm here in the U.S.
In the meantime, China's monthly exchange of export dollars for Treasuries allows the U.S. government to continue its deficit spending. Whether willing or unwilling, China has become the U.S. government's buyer of last resort, further complicating an already complicated relationship.
The U.S. and China are engaged in a simpatico partnership: China's export-driven economy is heavily reliant on the U.S. Meanwhile, America's consumption and debt-based economy and government are equally reliant on China.
Both countries have become dysfunctionally dependent on the other, to the point of mutual detriment.
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