U.S. Trade Deficit Dragging Down Economic Growth, Sending Billions Overseas

Warnings about the size of the federal budget deficit have made headlines for many years. We've repeatedly been cautioned about the threat the federal deficit poses to the U.S. However, we hear relatively little about the nation's trade deficit.

The U.S. has consistently run a gaping trade deficit for decades because we import more than we export. In fact, the U.S. has led the world in imports for decades and is also the world's biggest debtor nation.

Countries with big, persistent trade deficits have to continually borrow to fund themselves. The problem for the U.S. is that we don't export nearly enough to continue paying for all those cheap foreign goods that we've grown so accustomed to.

A trade surplus is preferable to a trade deficit since it generally implies that a nation's goods are competitive on the world stage, its citizens are not consuming too much, and that it is amassing capital for future investment and economic pursuits. The U.S. hasn't known such a position since 1975.

The trade deficit acts as a drag on economic growth because it means the U.S. is earning less on overseas sales of American-produced goods while spending more on foreign products. Buying goods from abroad means they are not being made here at home, and that displaces American jobs. Simply put, the trade gap subtracts from economic growth (GDP).

Each and every month, tens of billions of dollars are being drained out of the U.S. economy.

Such an imbalance has been able to exist for 36 years only because the U.S. has run a surplus in the trade of services (tourism, financial services, telecommunications, etc.). However, the overall trade deficit is unsustainable in the longer term. You can't buy more than you sell indefinitely.

This problem will not be easy to rectify. It can't be fixed in a quarter, a year, or even during a president's term. This is a structural problem, not merely a cyclical one. It has been decades in the making and at this point it will be very difficult to rectify.

There was some modest progress last year, however.

According to the U.S. Census Bureau, the U.S. trade deficit in goods and services declined from $559.9 billion in 2011 to $540.4 billion in 2012, an improvement of $19.5 billion (3.5 percent). It marked the first time in three years that the trade deficit fell.

Record exports, a drop in the cost of imported oil, and a slowdown in the country’s demand for imported consumer goods led to the decline.

However, there is no getting around the fact that the U.S. ran a trade deficit in excess of half a trillion dollars in successive years. And the problem remains persistent.

This year, the U.S. posted a trade deficit of $44.5 billion in January, $43.6 billion in February, $37.1 in March, $40.1 billion in April and $45.0 billion in May. That amounts to a cumulative deficit of $210.3 billion through the first five months of this year, meaning that the trade deficit is once again on track to exceed half a trillion dollars this year.

Oil has long been a major factor in the trade deficit. Yet, a structural shift is underway. While the U.S. trade deficit in petroleum goods declined $34.8 billion (10.7 percent), the U.S. trade deficit in non-petroleum goods increased $35.3 billion (8.8 percent).

As the Economic Policy Institute (EPI) put it:

"Growing goods trade deficits have eliminated millions of U.S. manufacturing jobs over the past decade, and non-petroleum goods were responsible for the vast majority of the jobs displaced. Rapidly growing trade deficits in non-petroleum goods, especially manufactured products, represent a substantial threat to the recovery of U.S. manufacturing employment."

Obviously, the trade deficit is the result of whole lot more than crude oil. We'll explore the role of oil in the trade deficit in a moment.

The good news was that the U.S. shipped a record $2.19 trillion in exports in 2012, despite significant economic headwinds around the world that undercut global trade. Europe, for example, is in a recession.

Exports as a share of GDP held steady at a record 13.9 percent, according to the Commerce Department. But that remains one of the lowest export levels in the world among large, industrialized nations. Clearly, the U.S. will not export its way to an economic recovery.

The U.S. relies heavily on consumption to drive its economy, yet American consumers are buying a disproportionate share of their goods from foreign nations. That doesn't help the U.S. economy much. Though cheap foreign goods help hold down consumer prices, they come at the expense of American jobs.

Americans are literally buying tons of foreign goods each month instead of making them here at home. That's a shortsighted policy.

Consumer spending now comprises 71% of the U.S. economy. Yet, far too much of that spending is directed toward foreign goods. For comparison, consumer spending was about 62% of GDP in 1960, when the economy was more balanced. At that time, the U.S. manufactured and exported far more than today.

Durable (6 percent) and non-durable (6 percent) manufacturing amount to just 12 percent of the U.S. economy. While the U.S. is still the world's leading manufacturer (by some estimates, China may have recently surpassed the U.S.), our share of global manufacturing has been declining for decades.

The U.S. share of global manufacturing now stands at 18%, down from 29% in 1970. And just 9 percent of U.S. workers are employed directly in manufacturing.

In January 2004, the number of manufacturing jobs stood at 14.3 million, down by 3.0 million jobs, or 17.5 percent, since July 2000 and about 5.2 million since the historical peak in 1979. Employment in manufacturing was its lowest since July 1950.

So, the decline in manufacturing is contributing to the trade deficit, which has been decades in the making. The U.S. has been running consistent trade deficits since 1976 due to high imports of oil and consumer products.

More than half of the U.S. trade deficit is with China, making it by far the largest deficit with any individual country. So far this year, the U.S. deficit with China is running 3% higher than last year.

While this trade deficit is benefitting the Chinese job market, it is hurting American workers.

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.

For many years, China has undervalued its currency (the yuan) in relation to the dollar to keep its products artificially inexpensive in the U.S. while discouraging U.S. exports to China. This policy is contributing to high unemployment in the U.S.

As noted earlier, one of the biggest drivers of the U.S. trade deficit is imported crude oil. Oil is priced in dollars and the dollar is buying less these days.

In 2001, the U.S. Dollar Index traded at around $120. Today, the U.S. Dollar Index is trading at $81, about 32 percent below the 2001 high. That's a serious decline in value in little more than a decade.

The weakened dollar is punishing Americans every time they fill up their gas tanks.

Though a declining dollar makes U.S. exports cheaper overseas, our No. 1 import is oil, which is also priced in dollars. A weak dollar makes oil, and ultimately gasoline, more expensive, forcing the trade deficit further into the negative.

Right now, virtually all developed nations are seeking to devalue their currencies to increase exports. But every country can't have a trade surplus. Someone has to buy. For decades, the primary buyer has been the U.S.

However, the reason our economy melted down in the first place was because it was built on a bubble of debt. American consumers simply cannot continue taking on ever more debt while serving as the world's primary consumer.

Many economists believe that a currency war is currently underway. Call it a race to the bottom.

Japan’s money-printing and bond-buying program is the latest salvo in the global currency war. The U.S., U.K. and Switzerland are already enjoined in the battle. In fact, nations that constitute around 70% of world economic output are “at war,” pursuing policies that cause devaluation and currency debasement to differing degrees. A weaker currency boosts exports, driven by cheaper prices.

However, just as every nation cannot be a net exporter, neither can every nation have the cheapest currency by implementing similar devaluation policies. And if everyone devalues, then what's the point?

As long as the trade deficit continues, the U.S. will have to continue borrowing from abroad to pay the difference. That's why the trade deficit is so pernicious.

Since imports shrink the nation's gross domestic product, U.S. GDP will continue to face downward pressure. Every $1 billion of a larger deficit subtracts about 0.1 of a percentage point from the annualized growth rate. That's bad news for an economy that is currently struggling to eek out a mere 2 percent growth rate.

The U.S., the world's No. 1 importer, has been able to run continual trade deficits for many years because it has been receiving an inflow of capital from surplus nations, such as China, Japan and Saudi Arabia. If these surplus nations ever hope to get repaid (i.e. to reverse those capital flows) then those trade imbalances must be reversed.

That will require less consumption, more saving and more production here at home, plus more consumption and less saving in places like China.

America needs to produce more, export more, and save more. For more than a quarter-century, we did exactly the opposite. And that's exactly what we need China to do now; import more and spend more.

No nation can continually buy more from abroad than it sells abroad. It's simple arithmetic. Where will the money for all the purchases come from?

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 those imbalances.