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In the second quarter, higher oil prices and surging imports of consumer goods from China drove the trade deficit. Also, the lack of exciting, reliable, fuel-efficient vehicles at General Motors and Ford weighed heavily as well. In the third quarter, the current account deficit was 6.8 percent of GDP and was financed largely by borrowing from foreigners, as opposed to foreigners investing in productive assets in the United States. Anatomy of the Current Account Deficit The United States had an $18.3 billion surplus on trade in services. This was hardly enough to offset the massive $218.6 billion deficit on trade in goods and the $3.8 billion deficit on interest, dividends and other transnational income payments. The remainder of the current account deficit came from U.S. transfer payments to foreign individuals and governments, which was $21.5 billion. The deficit on petroleum products was $75.2 billion, up from $71.4 billion in the first quarter. The price of imported petroleum rose 4.7 percent and the volume increased 3.4 percent. The deficit on automotive products was $35.5 billion. This deficit will rise in the future, because as U.S. production moves from the former Big Three to Toyota and other Asian transplants, the U.S. content of vehicles declines—transplants use fewer U.S.-made parts in their vehicles. Moreover, Korean automakers will continue inroads, challenging both Toyota and other Japanese transplants, which are developing their own cost problems. The restructuring programs announced at GM and Ford may provide a temporary return to profitability but will increase the automotive deficit further. Down the road, more cutbacks should be expected as the concessions offered by the UAW and corporate restructurings announced are inadequate to redress the domestic industry’s fundamental competitiveness problems. The Wal-Mart effect was broadly apparent. The trade deficit with China was $63.9 billion, up from $54.5 billion in the second quarter. Together, the deficit on petroleum and automotive products and with China totaled $170.8 billion or 78 percent of the $218.6 billion deficit on goods and services. The trade deficits on petroleum and automobile products are not much affected by recent exchange rate movements; therefore, the deficit on goods and services will not improve much, and in fact will likely worsen, until substantial progress is accomplished on China’s yuan and other protectionist practices. The dollar remains at least 40 percent overvalued against the Chinese yuan and other Asia currencies. China continues to peg against the dollar. Although China revalued the yuan from 8.28 to 8.11 in July 2005, and announced it would adjust the currency to a basket of currencies, the yuan continues to track the dollar very closely. Currently it is trading at about 7.84. Other Asian governments must conform their currency policies to China, lest they lose competitiveness in U.S. and European markets. To sustain undervalued currencies against the dollar, foreign governments purchased $80.8 billion in U.S. securities. This created a 14 percent subsidy on exports to the United States. If China were to revalue the yuan, the U.S. bilateral deficit with China could shift to other Asian exporters. However, to maintain their resulting large trade surpluses with the United States, these Asian nations would have to replicate China’s intervention in currency markets and transfer of buying power to Americans, which comes to 9 percent of China’s GDP. That would prove a Herculean task, and ultimately the dollar would trade lower against all Asian currencies, and the U.S. trade deficit would decline. Financing the Deficit The current account deficit must be financed by a capital account surplus, either by foreigners investing in the U.S. economy or loaning Americans money. Some analysts argue that the deficit reflects U.S. economic strength, because foreigners find many promising investments here. The details of U.S. financing belie this argument. In the third quarter, U.S. investments abroad were $223.8 billion, while foreigners invested $400.2 billion in the United States. Of that latter total, only $44.1 billion or 11 percent was direct investment in U.S. productive assets. Most of the remaining capital inflows were foreign purchases of Treasury securities, corporate bonds, bank accounts, currency, and other paper assets. Essentially, Americans borrowed $356.1 billion to consume about 6.8 percent more than they produced. Foreign governments loaned Americans $80.8 billion or 2.4 percent of GDP. That well exceeded net household borrowing to finance homes, cars, gasoline, and other consumer goods. The Chinese and other governments are essentially bankrolling the U.S. consumer. The cumulative effects of this borrowing are frightening. The total external debt now exceeds $5 trillion and will likely exceed $6 trillion by the end of 2006. That will come to about $20,000 for each American, and at 5 percent interest, $1000 per person.
Peter Morici pmorici@rhsmith.umd.edu
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