Justin Lahart (of the Wall Street Journal's Ahead of the Tape column) correctly called the fall in the monthly trade deficit last Thursday.
But he - channeling Jim Griffin of ING investment management - sees the November fall as the sign of good things to come. I don't.
And when I looked back at my post on the November trade numbers, I realized that my post was both rather dense and stuck deeply in the weeds - all y/y percentage changes and the like. So I wanted to step back a bit and look at some broader trends that underlie my pessimism. There clearly is a debate here: Some folks think the trade deficit has crested, others don't. Look at Macroblog's wrap of the reporting on the trade data. .
So what are the sources of the difference?
Let's start with imports. Lahart notes that US households have been slower to take on debt, "which over time, will mean that spending will grow by less, cutting into import growth and contributing to a narrower trade deficit." Fair point. Though imports are the product of both household spending and business investment, and if Richard Berner is right, capital spending may rise/ business savings may fall. I should also mention the expected rise in the fiscal deficit, which will support spending..
What's my counterargument? If you look at the US data, non-oil imports slowed early in 2005 - for a while there was no month over month or quarter over quarter growth. But they are now are picking up. Jay Bryson of Wachovia has a nice chart showing both the slowdown and the recent pick up.
For a while, non-oil imports were not growing at all, even as the economy and retail sales were. Now, even if the economy slows a bit, I suspect non-oil imports should pick up from its pace earlier this year. This in part reflects a correction in the global electronics business - too much inventory led to slowdown in late 2004/ early 2005, judging from semiconductors. But that correction now seems to be over. Asian exports - and US imports seem to be picking up.
Of course, over time, a sustained consumer slowdown should slow US non-oil import growth. But in the near-term, we may go through a period where non-oil import growth remains strong, as, in a sense, imports catch up with US growth during much of 2005. That at least is the trend I see in the recent pick-up in monthly non-oil imports. A stronger dollar also should, at the margin, shift demand toward foreign products. Toyota is ramping up production; GM is moving the other way.
Now exports. Lahart sees continued growth, since current US export growth is a sign "other countries economies are picking up steam."
I have a slightly different interpretation. No doubt, export growth was strong in both 2004 and 2005. 10% year over year growth is well above long-term trend growth for the US. Two forces contributed to that growth. First, export growth is a function of exchange rate moves, with a lag. So strong growth in 2004 reflected the lagged impact of the dollar's fall in 2003. Strong growth in 2005 benefited from the lagged impact of the dollar's fall in 2003 and 2004. Right now, though, the dollar remains above its close at the end of 2003. At a minimum, the lagged impact of a weaker dollar won't help US exports.
Second, global growth wasn't weak in 2004 or 2005. It was actually very, very strong in 2004. Europe and Japan may not have been doing great, but China, India and host of other countries were. Same in 2005. It is hard to tell a story where global growth is stronger in 2006 than it was in say 2004.
What may be changing is the composition of global growth. China, Germany and Japan may rely more on domestic demand for growth, and less on exports. That certainly would help.
On the other hand, German confidence seems based in part on the success of German exports; its robustness in the face of slowing US import growth remains unclear, at best. The latest data out of Germany hasn't been all that encouraging. And I want a bit more evidence the q4 pickup in Chinese imports signals a sustained shift in the pattern of Chinese growth before declaring that China has succeeded at changing the basis for its growth.
When I add it up on the export side, I see:
- Strong global growth + weak dollar (lagged) = 12.3% export growth in 2004.
- Strong (though not quite as strong) global growth and a very weak dollar (lagged) = 10-11% export growth in 2005.
- Strong global growth (maybe slightly more based on domestic demand) and a stronger dollar (lagged) in 2006 = less than 10% export growth.
Any wildcards -- forces that might propel faster than expected export growth with the dollar/ euro at 1.20? Maybe.
One: oil exporters should continue to import more of everything, as spending caches up with the surge in their export revenues. That may support US exports, though I still think it supports European exports far more.
Two: Boeing. It plans to produce 400 planes next year, up from a few under 300 this year. Its product line is now pretty much down to two planes: the 737 and the 777. Boeing only delivered 13 747s last year, and 10 767s. The 787 won't roll of the line in large numbers before 2008, and Boeing hasn't launched an advanced 747. But it selling lots of 737s and 777s. Airbus also relies on some US components. Demand for civil aircraft outside the US seems quite strong. Total exports of civil aircraft, engines and parts were up 13.4% in 2005, y/y. And it might be even stronger in 2006.
All in all, though, I doubt Boeing will save 2006.
I just don't see enough evidence to argue that US exports are likely to grow substantially faster than imports - and that is what has to happen to keep the deficit constant. Really reducing the deficit requires export growth that is about two times import growth. Look at the gap between imports and exports in Menzie Chinn's graphs.
Bringing the deficit down likely requires some kind of big shift. Either a big shift in the growth of domestic demand, with far faster growth outside the US than inside the US. Or a real trade-weighted dollar that is well below its historical average. In other words something has to change.
John Mauldin's latest Outside the Box column focused on dark matter, not the trade deficit per se. But a big part of Tim Drayson's argument (relayed by Mauldin) is that there is no way income from US investment income will offset a still rising trade deficit. My favorite part of the report: the charts showing the future US current account deficit if US imports and exports grow in line with previous economic cycles.
It isn't pretty. Drayson's bottom line: "Depending on your optimism about underlying trade flows, I think you could see a current account deficit of at least 8-9% of GDP by the end of the decade."
My long-term bottom line is no different than Drayson's bottom line. Something has to change to keep the deficit from growing. And right now, I don't see much evidence that enough has changed to be able to forecast that the 2006 trade deficit will fall. One of the key sources supporting fast export growth in 2004 and 2005 -- -- the weak dollar -- has dissipated. The other -- strong global growth driven by strong growth in emerging economies -- remains, but it could be weakening. And I doubt the forces that held down non-oil import growth in 2005 will be as strong in 2006. Time will tell.