Trade out of Whack: Making Sense of the Trade Deficit

By Stein, Steve | Policy Review, December 2004 | Go to article overview

Trade out of Whack: Making Sense of the Trade Deficit


Stein, Steve, Policy Review


IN OCTOBER, THE United States posted a 12-month trade deficit of nearly $600 billion. That figure has been rising steadily and breaking its own record month by month. Each increment adds to the United States' external debt, which is now estimated at over $2.6 trillion. The chart below shows how each has been increasing as a percentage of GDP.

Are these increases in the trade deficit and the external debt matters of great immediate concern? No, say a remarkably large number of respected economists, adding that the only imminent danger in these figures is that they might provoke unwise but irresistible calls for protectionism and other equally harmful measures.

One of those respected economists is Federal Reserve Board Chairman Alan Greenspan. Addressing a bankers' conference in May, Greenspan acknowledged that the trade deficit, at over 5 percent of GDP, was testing historic limits, especially since it was accompanied by a record budget deficit and record household debt. So why isn't Greenspan alarmed? Because, as the chairman said, the United States is simultaneously benefiting from a "one-time shift in the degree of globalization and innovation." Rapid industrialization and freer trade have lowered the cost of merchandise. The internationalization of investment and banking, coming at a time when America's robust capital markets are so attractive throughout the world, has lowered the cost of credit. The growing flexibility of world financial markets has made it easier for equity prices, product prices, and exchange rates to reestablish global balance without the sort of abrupt impacts on the U.S. economy that create crises.

However, Greenspan stressed that one-time shifts don't last forever, and lately his optimistic outlook appears somewhat dampened by the large and ongoing accumulation of dollar assets by Asian central banks. In November, when he told another banking conference that "net claims against U.S. residents cannot continue to increase forever in international portfolios at their recent pace," Wall Street reacted as though it had received new and unpleasant information. At any rate, those massive currency interventions, particularly by China and Japan, have kept the dollar artificially high and Asian imports artificially cheap, and they trouble some economists much more than they do Greenspan. Former Treasury Secretary Lawrence Summers, for one, worries that the United States has found no effective way of preventing these currency transactions.

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In fact, Summers shares little of Greenspan's calm view of the trade deficit, and is especially concerned about the geopolitical implications of the rising external debt. "There is surely something odd," Summers told a group at the International Institute of Economics, "about the world's greatest power being the world's greatest debtor." He has a point. While it isn't easy for other nations to use the threat of calling that debt in order to achieve other political ends, neither is it impossible. The situation of the U.S. today stands in sharp contrast, for example, to that of the British Empire in the nineteenth century, when it was both the world's major power and major creditor.

Divided commission

IT IS NO SURPRISE that a Federal Reserve chairman and a former secretary of the Treasury from different political parties view a highly charged issue like the trade deficit from dissimilar perspectives. International trade has always been a subject from which professionals can draw vastly different conclusions using the same set of facts. At least Summers and Greenspan do share large areas of agreement, which is more than can be said of some of their colleagues.

When Congress established the Trade Deficit Review Commission in 1999, it may have foreseen an end product that would represent bipartisan consensus. The commission's final report was well-researched and thorough, but bipartisan it definitely was not. …

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