The Trade Deficit fell in September to $44.00 billion after it rose in August to $46.48 billion. The fall in the trade deficit is very good news for the economy. The trade deficit was also smaller than the $44.8 billion consensus expectation. On a year-over-year basis, the total trade deficit was up 25.1% from $35.16 billion a year ago.
The trade balance has two major parts, trade in goods and trade in services. America's problem is always on the goods side; we actually routinely have a small surplus in services. Relative to August, the goods deficit fell to $56.87 billion from $59.12 billion. That is a month-to-month decline of 5.3%. Relative to a year ago, the goods deficit was up 22.9% from $46.27 billion.
The service surplus was up only slightly (1.8%) from August at $12.87 billion, and up 15.9% from last years' $11.10 billion. Exports of goods were virtually unchanged at $107.60. Relative to a year ago, goods exports are up 16.9%.
In other words, we are easily on pace to meet President Obama's goal of doubling exports of goods over the next five years. Service exports, on the other hand, were up just 1.0% for the month, but were up 10.4% year over year, which is well short of the pace needed to double over five years.
Doubling exports over five years is all well and good, but not if we also double our imports over the same timeframe. After all, it is net exports which are important to GDP growth, and to employment. The monthly numbers were somewhat encouraging in this regard, as goods imports fell by $2.22 billion, or 1.3% to $164.43 billion.
Relative to a year ago, goods imports are up $26.15 billion or 18.9%. At that pace, they would be up 137.6% over five years, while goods exports would be up just 118.3%, and are starting from a much higher base. Thus, the goods trade deficit would be much higher five years from now than it is today.
Put another way, in August we bought from abroad $1.53 worth of stuff for every dollar of stuff we sold. That was a bit of an improvement from the $1.55 worth of stuff in August, but worse than the $1.50 worth of stuff a year ago.
On the service side, both imports (up 0.75%) and exports (up 1.03%) were up slightly from August. Relative to a year ago, service exports are up 10.4% while service imports are up 8.4%.
Year-to-Date Numbers Still Astound
On a year-to-date basis for the first nine months of the year, the total trade deficit is up an astounding 82.97% to $379.12 billion, with the goods deficit up 34.1%, some what offset by the service sector surplus rising 16.8%. Then again, trade in goods simply swamps trade in services.
All things being equal, it is better to see trade going up than down. We want to see both exports and imports growing, but given the massive deficit we are running, we need to have exports rise dramatically faster than imports, or actually see imports fall.
A big part of what made the Great Recession into a global downturn was an absolute collapse in global trade. This can clearly bee seen in the long-term graph of our imports and exports below (from http://www.calculatedriskblog.com/). Falling imports and exports are clearly associated with recessions.
In the Great Recession our imports collapsed faster than our exports, and so we had a very big improvement in the trade deficit. That was just about the only thing keeping the economy on life support during those dark days. For example, in the first quarter of 2009 the smaller trade deficit increased growth by 2.64%. If not for that, the economy would have shrunk by 9.0% instead of by 6.4%.
Thus, growing world trade is a good thing, but not if it comes at the expense of an ever-rising U.S. trade deficit. On the other hand, had it not been for a dramatic deterioration in the trade deficit, in the second quarter of this year, GDP growth would have been over 5%, not 1.7%. In the third quarter it would have been 4.0% rather than 2.0%. The somewhat better-than-expected trade numbers for September increase the chances that when the next peek at the third quarter GDP numbers come out, the number will be revised up a little bit.
The sort of growth the economy is generating if the trade deficit is excluded is robust enough to start to produce significant numbers of jobs. Of course, though you can't just ignore the trade deficit. ("Other than that Jackie, did you have fun on your trip to Dallas?")
The trade deficit is a far more serious economic problem, particularly in the short to medium term, than is the budget deficit. In the third quarter, the increase in the trade deficit subtracted a full 2.00 points from the economic growth rate. If we had somehow managed to keep the trade deficit at the same level as in the second quarter, then second quarter growth would have been 4.0%, not 2.0%.
The trade deficit is directly responsible for the increase in the country's indebtedness to the rest of the world, not the budget deficit. That is not just a matter of opinion, that is an accounting identity.
Think about it this way, during WWII the Federal Government ran budget deficits that were FAR larger as a percentage of GDP than we are running today, but we emerged from the war the biggest net creditor to the rest of the world that the world had ever seen up to that point. Then the Federal government owed a lot of money, but it owed it to U.S. citizens, not to foreign governments.
Slowly but surely the trade deficit is bankrupting the country. While most of the foreign debt is in T-notes, try think of it as if we were selling off companies instead of T-notes. This month's trade deficit is the equivalent of the country selling off DuPont (DD), while last month's deficit was the equivalent of selling off Bristol Meyers (BMY). How long would it take before every major company in the U.S. was in foreign hands if this keeps up indefinitely?
Put another way, if the September trade deficit were maintained for the full year, it would total $528.0 billion, which is almost as much as all the firms in the S&P 500 earned, worldwide, in 2009.
Goods Deficit & Oil Addiction
The goods deficit has two major parts -- that which is due to our oil addiction and that which is due to all the stuff that line the shelves of Wal-Mart (WMT). Of the total goods deficit of $56.87 billion, $21.57 billion, or 37.9% is due to our oil addition.
The second graph (also from http://www.calculatedriskblog.com/) breaks down the deficit into its oil and non-oil parts over time. It shows that the overall trade deficit (blue line) deteriorated sharply from 1998 to mid-2005 and then remained at just plain awful levels until the financial meltdown caused world trade to come to a screeching halt.
That caused a major but unfortunately short-lived improvement in the overall deficit. However, the stabilization in the non-oil deficit started about two years earlier, but that was offset by the effects of soaring oil prices which caused the oil side of the deficit to deteriorate sharply.
The monthly improvement in the goods deficit came mostly from the non-oil side, where the deficit fell to $33.92 billion from $35.98 billion, but still well above the $25.35 billion level of a year ago. That is a deterioration of $8.56 billion or 33.8%.
The oil deficit fell by $392 million on the month, from $21.96 billion to $21.57 billion, a 1.8% improvement. Relative to a year ago, oil side of the deficit rose by 5.1%. For the first nine months of the year, the non oil deficit is up by $59.59 billion or 26.9%, while the oil side is up by $58.23 billion or 40.7%.
The oil side should be the low hanging fruit to bring down the overall trade deficit and thus help spur economic growth. Oil is primarily used as a transportation fuel. But the technology exists and is widely used abroad to use natural gas to power cars and trucks. Thanks to the emerging shale plays, we have ample domestic supplies of natural gas, and on a per BTU basis, natural gas is selling for the equivalent of oil at $25.02 per barrel.
The Chicken & the Egg
We need to get past the chicken and the egg problem of nobody wanting to buy a natural gas-powered vehicle because there are no convenient places to refuel, and gas stations reluctance to install refueling stations for natural gas powered vehicles since there are not many of them on the road.
Not only would such a move save money for drivers in the long run (there is an upfront capital cost as natural gas powered engines are more expensive than regular gasoline powered engines), but it would substantially reduce our trade deficit. Since it is a domestically produced fuel (and most of what we do import, we import from Canada) there is also a huge national security argument for moving to using more natural gas.
The dollars we send abroad to pay for oil imports are simply the tip of the iceberg when it comes to the overall cost of oil. A substantial portion of the Pentagon budget is devoted to keeping the oil flowing in the Middle East and the sea routes open. While I don't think that oil was the only reason for our being in Iraq, it is clearly a significant factor.
Natural gas is also a much cleaner fuel and emits far less CO2 than does gasoline. Thus it would be a very useful step towards stopping global warming.
Doing this, especially breaking the chicken and the egg problem, will take federal government leadership. The benefits for the economy however, would be huge. It seems inevitable to me that it will eventually happen, and when it does, it will be a great boon to major natural gas producers like Chesapeake (CHK) and EnCana (ECA).
The timing of it happening is very uncertain, but the sooner it happens, the better. I don't want to minimize the cost of doing so, particularly in terms of water quality. We need to do more research on the chemicals used in fracking operations to get at the shale gas (starting with getting rid of the trade secrets provision that allows the firms to hide exactly what they are putting into the ground and potentially the groundwater). Still, it strikes me as a trade-off worth making.
Trade Deficit & Weak Dollar
The best thing that could happen to help on the non-oil side of the trade deficit would be for the dollar to fall. The strong dollar not only makes imports cheaper, it makes our exports more attractive.
The recent decline in the dollar clearly has not yet affected the overall trade deficit, but there is often a lag between currency movements and changes in trade patterns. It is not just a direct effect of say our being able to sell more goods in Japan because the dollar is weak relative to the yen, but U.S. companies are often in direct competition with Japanese or European companies in selling to third countries.
For example, both General Electric (GE) and Siemens (SI) make MRI machines for hospitals. Assuming that they were of roughly equal quality, then when the Euro rises sharply against the dollar, GE is going to be able to undercut Siemens for export orders to China.
By country, we ran some small trade surpluses with Hong Kong, Singapore and Australia, but we continue to run large deficits with most of our other trading partners. The biggest deficit by far is with China, the source of many of the goods on the shelves of Wal-Mart. It increased sharply this month, rising to $28.0 billion from $25.9 billion. That is 60.4% of our overall trade deficit.
While China has agreed to let the Yuan appreciate, so far it has done so at only a glacial pace. Our deficit with the European Union fell this month rising to $8.1 billion from $9.9 billion. That was offset by increases in our bilateral trade deficits with OPEC ($9.0 billion vs. $8.0 billion), Mexico ($6.0 billion vs. $5.3 billion) and Canada ($2.2 billion vs. $1.4 billion).
Our Take: Negative Report
Overall, this was a very negative report. While not as bad as the June deficit, it really does dash hopes that the trade deficit could be a source of substantial economic growth in the third quarter. Getting the trade deficit under control has to be one of the top economic priorities. If we do, economic growth will be much higher, and we might actually start to see some significant job creation.
With the rise in employment will come higher tax revenues, which will help bring the budget deficit under control. To do that we need to do two things: first, get our oil addiction under control. The second is that “King Dollar” needs to meet the same fate as Charles I and Louis XVI. Off with his head!
The Fed seems to understand this, and a weaker dollar is one of the more important mechanisms through which quantitative easing will tend to stimulate the real economy. The U.S. can simply no longer afford to be the importer of last resort for the rest of the world.
As worldwide trade deficits and surpluses have to sum to zero (barring the opening of major trade routes to Alpha Centauri) a reduction in the U.S. trade deficit has to mean that the trade surpluses of other countries has to fall (or other deficit countries have to run even bigger deficits).
Right now every country in the world is trying to maximize exports and minimize imports. We have to fight that battle as well, but it is a fight where we have been getting out butts kicked for decades now. Continuing to lose the fight could result in near fatal damage to our economy and way of life. As I said before, the trade deficit is a far bigger economic problem than the budget deficit.
The downside of a weaker dollar is that it will tend to push up inflation. However, at this point, deflation is a bigger threat than runaway inflation (although with QE2, the risk of deflation would be substantially reduced).
The trade balance has two major parts, trade in goods and trade in services. America's problem is always on the goods side; we actually routinely have a small surplus in services. Relative to August, the goods deficit fell to $56.87 billion from $59.12 billion. That is a month-to-month decline of 5.3%. Relative to a year ago, the goods deficit was up 22.9% from $46.27 billion.
The service surplus was up only slightly (1.8%) from August at $12.87 billion, and up 15.9% from last years' $11.10 billion. Exports of goods were virtually unchanged at $107.60. Relative to a year ago, goods exports are up 16.9%.
In other words, we are easily on pace to meet President Obama's goal of doubling exports of goods over the next five years. Service exports, on the other hand, were up just 1.0% for the month, but were up 10.4% year over year, which is well short of the pace needed to double over five years.
Doubling exports over five years is all well and good, but not if we also double our imports over the same timeframe. After all, it is net exports which are important to GDP growth, and to employment. The monthly numbers were somewhat encouraging in this regard, as goods imports fell by $2.22 billion, or 1.3% to $164.43 billion.
Relative to a year ago, goods imports are up $26.15 billion or 18.9%. At that pace, they would be up 137.6% over five years, while goods exports would be up just 118.3%, and are starting from a much higher base. Thus, the goods trade deficit would be much higher five years from now than it is today.
Put another way, in August we bought from abroad $1.53 worth of stuff for every dollar of stuff we sold. That was a bit of an improvement from the $1.55 worth of stuff in August, but worse than the $1.50 worth of stuff a year ago.
On the service side, both imports (up 0.75%) and exports (up 1.03%) were up slightly from August. Relative to a year ago, service exports are up 10.4% while service imports are up 8.4%.
Year-to-Date Numbers Still Astound
On a year-to-date basis for the first nine months of the year, the total trade deficit is up an astounding 82.97% to $379.12 billion, with the goods deficit up 34.1%, some what offset by the service sector surplus rising 16.8%. Then again, trade in goods simply swamps trade in services.
All things being equal, it is better to see trade going up than down. We want to see both exports and imports growing, but given the massive deficit we are running, we need to have exports rise dramatically faster than imports, or actually see imports fall.
A big part of what made the Great Recession into a global downturn was an absolute collapse in global trade. This can clearly bee seen in the long-term graph of our imports and exports below (from http://www.calculatedriskblog.com/). Falling imports and exports are clearly associated with recessions.
In the Great Recession our imports collapsed faster than our exports, and so we had a very big improvement in the trade deficit. That was just about the only thing keeping the economy on life support during those dark days. For example, in the first quarter of 2009 the smaller trade deficit increased growth by 2.64%. If not for that, the economy would have shrunk by 9.0% instead of by 6.4%.
Thus, growing world trade is a good thing, but not if it comes at the expense of an ever-rising U.S. trade deficit. On the other hand, had it not been for a dramatic deterioration in the trade deficit, in the second quarter of this year, GDP growth would have been over 5%, not 1.7%. In the third quarter it would have been 4.0% rather than 2.0%. The somewhat better-than-expected trade numbers for September increase the chances that when the next peek at the third quarter GDP numbers come out, the number will be revised up a little bit.
The sort of growth the economy is generating if the trade deficit is excluded is robust enough to start to produce significant numbers of jobs. Of course, though you can't just ignore the trade deficit. ("Other than that Jackie, did you have fun on your trip to Dallas?")
The trade deficit is a far more serious economic problem, particularly in the short to medium term, than is the budget deficit. In the third quarter, the increase in the trade deficit subtracted a full 2.00 points from the economic growth rate. If we had somehow managed to keep the trade deficit at the same level as in the second quarter, then second quarter growth would have been 4.0%, not 2.0%.
The trade deficit is directly responsible for the increase in the country's indebtedness to the rest of the world, not the budget deficit. That is not just a matter of opinion, that is an accounting identity.
Think about it this way, during WWII the Federal Government ran budget deficits that were FAR larger as a percentage of GDP than we are running today, but we emerged from the war the biggest net creditor to the rest of the world that the world had ever seen up to that point. Then the Federal government owed a lot of money, but it owed it to U.S. citizens, not to foreign governments.
Slowly but surely the trade deficit is bankrupting the country. While most of the foreign debt is in T-notes, try think of it as if we were selling off companies instead of T-notes. This month's trade deficit is the equivalent of the country selling off DuPont (DD), while last month's deficit was the equivalent of selling off Bristol Meyers (BMY). How long would it take before every major company in the U.S. was in foreign hands if this keeps up indefinitely?
Put another way, if the September trade deficit were maintained for the full year, it would total $528.0 billion, which is almost as much as all the firms in the S&P 500 earned, worldwide, in 2009.
Goods Deficit & Oil Addiction
The goods deficit has two major parts -- that which is due to our oil addiction and that which is due to all the stuff that line the shelves of Wal-Mart (WMT). Of the total goods deficit of $56.87 billion, $21.57 billion, or 37.9% is due to our oil addition.
The second graph (also from http://www.calculatedriskblog.com/) breaks down the deficit into its oil and non-oil parts over time. It shows that the overall trade deficit (blue line) deteriorated sharply from 1998 to mid-2005 and then remained at just plain awful levels until the financial meltdown caused world trade to come to a screeching halt.
That caused a major but unfortunately short-lived improvement in the overall deficit. However, the stabilization in the non-oil deficit started about two years earlier, but that was offset by the effects of soaring oil prices which caused the oil side of the deficit to deteriorate sharply.
The monthly improvement in the goods deficit came mostly from the non-oil side, where the deficit fell to $33.92 billion from $35.98 billion, but still well above the $25.35 billion level of a year ago. That is a deterioration of $8.56 billion or 33.8%.
The oil deficit fell by $392 million on the month, from $21.96 billion to $21.57 billion, a 1.8% improvement. Relative to a year ago, oil side of the deficit rose by 5.1%. For the first nine months of the year, the non oil deficit is up by $59.59 billion or 26.9%, while the oil side is up by $58.23 billion or 40.7%.
The oil side should be the low hanging fruit to bring down the overall trade deficit and thus help spur economic growth. Oil is primarily used as a transportation fuel. But the technology exists and is widely used abroad to use natural gas to power cars and trucks. Thanks to the emerging shale plays, we have ample domestic supplies of natural gas, and on a per BTU basis, natural gas is selling for the equivalent of oil at $25.02 per barrel.
The Chicken & the Egg
We need to get past the chicken and the egg problem of nobody wanting to buy a natural gas-powered vehicle because there are no convenient places to refuel, and gas stations reluctance to install refueling stations for natural gas powered vehicles since there are not many of them on the road.
Not only would such a move save money for drivers in the long run (there is an upfront capital cost as natural gas powered engines are more expensive than regular gasoline powered engines), but it would substantially reduce our trade deficit. Since it is a domestically produced fuel (and most of what we do import, we import from Canada) there is also a huge national security argument for moving to using more natural gas.
The dollars we send abroad to pay for oil imports are simply the tip of the iceberg when it comes to the overall cost of oil. A substantial portion of the Pentagon budget is devoted to keeping the oil flowing in the Middle East and the sea routes open. While I don't think that oil was the only reason for our being in Iraq, it is clearly a significant factor.
Natural gas is also a much cleaner fuel and emits far less CO2 than does gasoline. Thus it would be a very useful step towards stopping global warming.
Doing this, especially breaking the chicken and the egg problem, will take federal government leadership. The benefits for the economy however, would be huge. It seems inevitable to me that it will eventually happen, and when it does, it will be a great boon to major natural gas producers like Chesapeake (CHK) and EnCana (ECA).
The timing of it happening is very uncertain, but the sooner it happens, the better. I don't want to minimize the cost of doing so, particularly in terms of water quality. We need to do more research on the chemicals used in fracking operations to get at the shale gas (starting with getting rid of the trade secrets provision that allows the firms to hide exactly what they are putting into the ground and potentially the groundwater). Still, it strikes me as a trade-off worth making.
Trade Deficit & Weak Dollar
The best thing that could happen to help on the non-oil side of the trade deficit would be for the dollar to fall. The strong dollar not only makes imports cheaper, it makes our exports more attractive.
The recent decline in the dollar clearly has not yet affected the overall trade deficit, but there is often a lag between currency movements and changes in trade patterns. It is not just a direct effect of say our being able to sell more goods in Japan because the dollar is weak relative to the yen, but U.S. companies are often in direct competition with Japanese or European companies in selling to third countries.
For example, both General Electric (GE) and Siemens (SI) make MRI machines for hospitals. Assuming that they were of roughly equal quality, then when the Euro rises sharply against the dollar, GE is going to be able to undercut Siemens for export orders to China.
By country, we ran some small trade surpluses with Hong Kong, Singapore and Australia, but we continue to run large deficits with most of our other trading partners. The biggest deficit by far is with China, the source of many of the goods on the shelves of Wal-Mart. It increased sharply this month, rising to $28.0 billion from $25.9 billion. That is 60.4% of our overall trade deficit.
While China has agreed to let the Yuan appreciate, so far it has done so at only a glacial pace. Our deficit with the European Union fell this month rising to $8.1 billion from $9.9 billion. That was offset by increases in our bilateral trade deficits with OPEC ($9.0 billion vs. $8.0 billion), Mexico ($6.0 billion vs. $5.3 billion) and Canada ($2.2 billion vs. $1.4 billion).
Our Take: Negative Report
Overall, this was a very negative report. While not as bad as the June deficit, it really does dash hopes that the trade deficit could be a source of substantial economic growth in the third quarter. Getting the trade deficit under control has to be one of the top economic priorities. If we do, economic growth will be much higher, and we might actually start to see some significant job creation.
With the rise in employment will come higher tax revenues, which will help bring the budget deficit under control. To do that we need to do two things: first, get our oil addiction under control. The second is that “King Dollar” needs to meet the same fate as Charles I and Louis XVI. Off with his head!
The Fed seems to understand this, and a weaker dollar is one of the more important mechanisms through which quantitative easing will tend to stimulate the real economy. The U.S. can simply no longer afford to be the importer of last resort for the rest of the world.
As worldwide trade deficits and surpluses have to sum to zero (barring the opening of major trade routes to Alpha Centauri) a reduction in the U.S. trade deficit has to mean that the trade surpluses of other countries has to fall (or other deficit countries have to run even bigger deficits).
Right now every country in the world is trying to maximize exports and minimize imports. We have to fight that battle as well, but it is a fight where we have been getting out butts kicked for decades now. Continuing to lose the fight could result in near fatal damage to our economy and way of life. As I said before, the trade deficit is a far bigger economic problem than the budget deficit.
The downside of a weaker dollar is that it will tend to push up inflation. However, at this point, deflation is a bigger threat than runaway inflation (although with QE2, the risk of deflation would be substantially reduced).
Dirk van Dijk, CFA is the Chief Equity Strategist for Zacks.com. With more than 25 years investment experience he has become a popular commentator appearing in the Wall Street Journal and on CNBC. Dirk is also the Editor in charge of the market beating Zacks Strategic Investor service.