US trade gap: a bright spot?

The improving balance of trade in the United States has been hailed as one of the few bright spots in the faltering US economy. Yet the narrowing trade deficit, which has been attributed to the weakening dollar and strong global demand for US exports, could be painful to US consumers.

The first graph shows that Washington's trade deficit traditionally slackens during periods of recession or exiguous economic growth: note the narrowing of the deficit in 1991 and 2001. The second graph shows that the same is likely to happen in 2007:

• Total September exports of $140.1 billion and imports of $196.6 billion gave a goods and services deficit of $56.5 billion, compared with $56.8 billion for August.
• Over the first nine months of the year, the deficit stood at $527.5 billion, down from $581.6 billion for the same period in 2006.
• Exports have reached record levels for each of the past seven months, the longest surge since 2000.

The narrowing trade gap shows that US exporters are finding good overseas markets for their products, but that US consumers are also checking their free-spending ways in response to the sub-prime crisis.

Washington will hope that this trade deficit does not narrow too quickly. Many economists calculate current account deficits -- which occur when more money is being paid out than brought into a country -- as a percentage of GDP. At the end of 2005, the US current account deficit hit a record of 6.8% of GDP. During the second quarter of this year it was down to 5.5%, and it looks likely to shrink at a faster rate.

This could be painful. Over the last 20 years, Americans have been borrowing and buying while the rest of the world has been lending and selling. If these foreign funds dry up, the dollar could tumble further, interest rates go up and the economic slowdown turn into a recession.

Each of these threats bears elaboration:

• The weak dollar may be redressing the balance of trade, but it also appears to be stoking inflation by driving up import prices. Import prices surged 1.8% month-on-month in October, bringing the year-on-year rise to 9.6%. Although the jump was largely a product of the rocketing price of oil, which is approaching record levels in real terms, import prices excluding fuels are up 2.4% over the year ending last month.
• Interest rates may have to rise to keep prices in check and offer higher yields to tempt foreigners to plough their money into the United States.
• Domestic spending growth is expected to slow as consumers wilt under pressure from falling house prices and rising energy prices.

Washington will hope that the trade gap narrows gradually to allow the recent run of US prosperity to continue, albeit in a more subdued fashion. This underlines the importance of continued strong export growth to keep driving the US economy.