Opinion: Growing US trade deficit points to suppressed inflation

In 2018, the US trade deficit hit $621 billion, up over 12 per cent compared to the previous year.  This is still below the record high $761 billion set in 2006.  

US trade deficit worsened despite tariffs on Chinese goods and steel and aluminum from a range of countries

By John Kemp

The United States ran a trade deficit on goods and services of $621 billion in 2018, up more than 12 per cent compared with the previous year, but still below the record $761 billion set back in 2006.

Deteriorating performance on other merchandise is being partly offset by a shrinking deficit on petroleum and a growing surplus in services such as finance, insurance, intellectual property, research and travel.

The country’s surplus on services such rose to $270 billion, from $255 billion in 2017, and just $76 billion back in 2006, according to government data published on Wednesday.

But the deficit on goods hit a record $891 billion, up from $807 in 2017, and easily exceeding the previous peak of $828 billion in 2006, according to the US Census Bureau.

The steadily worsening merchandise deficit is a sign domestic demand is outstripping the economy’s productive potential, with excess demand leaking abroad through a widening trade gap and a higher exchange rate.

The deteriorating external position is being masked somewhat by the shale revolution and the associated surge in domestic oil and gas production, which has slashed the bill for petroleum imports.

The petroleum deficit was just $53 billion last year, down from a peak of $386 billion in 2008 and $271 billion in 2006 (“US international trade in goods and services”, Census Bureau, March 6).

But the deficit on other merchandise surged to a record $825 billion, up from $557 billion in 2006.

The goods gap continued to worsen last year despite the imposition of tariffs on imports from China and on steel and aluminium from a range of countries.

The widening deficit reflects macroeconomic forces, principally the fact the US economy grew much faster than most trading partners over the last 12 months, sucking in imports faster than it could grow exports.

At the same time, the US currency appreciated against the currencies of most other major trading partners, hurting the competitiveness of US exporters and import-competing firms.

As a result, goods and services imports increased by $218 billion (7.5 per cent) last year compared with growth in exports of just $148 billion (6.3 per cent).

External imbalance

US policymakers have noted the improvement in the country’s internal balance, with inflation remaining well contained despite unemployment rates falling to multi-decade lows.

But the improvement in the internal balance has come at the expense of a deterioration in the external balance, with the trade gap widening significantly.

Increasing deficits are a sign of suppressed inflation, as domestic consumption and investment outstrip the growth in the economy’s productive capacity.

The federal government has significantly loosened fiscal policy over the last two years, cutting taxes while government spending has continued to increase at more than 4 per cent per year.

The Federal Reserve has responded by tightening monetary policy to keep inflation in check, pushing up the exchange rate and exacerbating the trade gap.

Fed tightening has drawn sharp criticism from the president, but it was a predictable textbook response to fiscal expansion in an economy nearing full employment.

Dollar appreciation and a growing trade gap are the only things that have allowed the United States to have fiscal stimulus AND low unemployment AND low inflation.

If the Fed were to cut interest rates in an attempt to weaken the dollar, the mostly likely outcome would be a surge in import prices, which would filter through to faster inflation, other things equal.

Depreciating the exchange rate to switch demand to exporters and import-competing firms would also tighten the labour market and capacity utilization still further.

Given unemployment is already near 50-year lows, and the economy has relatively little slack on most measures, the result would most likely be an acceleration in wage and price increases.

The United States cannot have a smaller trade deficit without accepting a slowdown in domestic growth, faster inflation, or both.

The appreciating exchange rate and widening trade deficit are both symptoms of an economic expansion that is very mature.

John Kemp is a Reuters market analyst. The views expressed are his own.

Editing by David Evans

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