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US trade deficit is a significant cause of recession

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Peter Morici
Online Journal
Thursday, Feb 12, 2009

Yesterday, the Commerce Department reported the 2008 deficit on international trade in goods and services was $677.1 billion. This is down from $700.3 billion in 2007 but still 4.7 percent of GDP. The trade deficit was smaller in 2008, because economic growth and consumer spending began to decline during the second half 2008.

Trade deficits and shoddy banking practices pushed the economy into recession, and until both trade and the banks are fixed, sustained economic growth cannot be accomplished. The trade deficit will rise again as the effects of the stimulus package are felt, but if its underlying causes are not addressed, the trade deficit will drag the economy back down into a double dip recession.

Pushed up by the surge in oil prices and the ballooning trade gap with China, the trade deficit is reducing U.S. GDP by $400 billion, annually, and significantly adding to the pain imposed by the unfolding recession. The negative effects of the trade deficit on GDP and employment overwhelm the potential positive effects of President Obama’s proposed stimulus spending.

To finance the deficit of recent years, Americans have borrowed more than $6.5 trillion from foreign sources, including foreign governments, and the debt service comes to more than $1,500 for each working American. In addition, foreign investors have invested at least $3.6 billion acquiring equities in U.S. businesses.

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US trade deficit is a significant cause of recession 161008pptv3

The flood of dollars into foreign government hands has bloated sovereign wealth funds that are now buying significant shares of U.S. businesses and other property, and threaten to compromise the loyalties of U.S. businesses.

  • A d v e r t i s e m e n t

The Chinese government alone holds about $2 trillion in U.S. and other securities, and these could be used to purchase about 20 percent of the value of publicly traded U.S. companies. Add to that the holding of Middle East sovereigns and royal families, the potential purchases of U.S. businesses by foreign governments with interests unfriendly to the United States is alarming.

This should give Americans real pause for concern about Chinese and other foreign government intentions to diversify their foreign exchange holdings into U.S. stocks and other real assets.

Anatomy of the hemorrhaging current account

In 2008, the United States had a $144.1 billion surplus on trade in services. This was hardly enough to offset the massive $821.2 billion deficit on trade in goods.

The deficit on petroleum products was $386.3 billion, up from $293.2 billion in 2007. The average price for imported crude oil rose to $95.23 from $64.28 percent from 2007, while the volume of petroleum imports fell 4.0 percent.

Also, the American appetite for inexpensive imported consumer goods and cars is a huge factor driving up the trade deficit. The trade deficit with China was $266.3 billion, a new record and up from $256.2 billion in 2007.

The deficit on motor vehicle products was $107.1 billion. Ford and GM continue to push their procurement offshore and cede market share to Japanese and Korean companies. However, the automotive trade deficit was down from $120.9, as Asian automakers continued to expand production in North America and demand for autos fell with the recession.

The trade deficit should ease in 2009 with lower oil prices and as the recession bears down on consumer spending. However, China is not permitting its currency to rise in value, despite its trade surplus and has beefed up subsidies on its exports in an effort to export its unemployment to the United States and other industrialized countries. China’s beggar-thy-neighbor protectionism threatens to ignite a global trade war of devastating proportions.

In 2010, as stimulus spending in the United States and elsewhere lifts economic activity, the trade deficit will increase again, oil prices will surge and China’s exports will rise above 2008 levels, thanks to an undervalued currency and larger export subsidies. The U.S. trade deficit will rise beyond its peak of 5.1 percent of GDP, and this may well pull the U.S. economy back into recession.

Dollars spent on imported oil and cars and consumer goods from China cannot be spent on U.S. goods and services, and every dollar that U.S. imports exceed exports negates at least one dollar of federal stimulus spending. Overall, the trade deficit overwhelms the positive effects of the Obama stimulus package on demand for U.S. goods and services, GDP and employment. Along with the banking crisis, the trade deficit is a primary cause of the U.S. recession.

The dollar remains at least 40 to 50 percent overvalued against the Chinese yuan and other Asian currencies. Although China adjusted the yuan from 8.28 per dollar to 8.11 in July 2005 and permitted it to rise gradually to 6.84 by July 2008, the value of the yuan has not changed since.

To sustain an undervalued currency in 2008, China purchased approximately $600 billion in U.S. and other foreign securities, creating a 40 percent subsidy on its exports of goods and services. Other Asian governments align their currency policies with China to avoid losing competitiveness to Chinese products in lucrative U.S. and EU markets.

Consequences for economic growth

High and rising trade deficits tax economic growth. Specifically, each dollar spent on imports that is not matched by a dollar of exports reduces domestic demand and employment, and shifts workers into activities where productivity is lower.

Productivity is at least 50 percent higher in industries that export and compete with imports, and reducing the trade deficit and moving workers into trade-competing industries would increase GDP.

Were the trade deficit cut in half, GDP would increase by at least $400 billion, or about $2,750 for every working American. Workers’ wages would not be lagging inflation, and ordinary working Americans would more easily find jobs paying higher wages and offering decent benefits.

Manufacturers are particularly hard hit by this subsidized competition. Through the recent economic expansion and recession, the manufacturing sector has lost 4.6 million jobs since 2000. Following the patterns of past economic expansions, the manufacturing sector should have kept at least 2 million of those jobs, especially given the very strong productivity growth accomplished in durable goods and throughout manufacturing.

Longer-term, persistent U.S. trade deficits are a substantial drag on growth. U.S. import-competing and export industries spend three-times the national average on industrial R&D, and encourage more investments in skills and education than other sectors of the economy. By shifting employment away from trade-competing industries, the trade deficit reduces U.S. investments in new methods and products, and skilled labor.

Cutting the trade deficit in half would boost U.S. GDP growth by one percentage point a year, and the trade deficits of the last two decades have reduced U.S. growth by one percentage point a year.

Lost growth is cumulative. Thanks to the record trade deficits accumulated over the last 20 years, the U.S. economy is about $3 trillion smaller. This comes to about $20,000 per worker.

Had the administration and the Congress acted responsibly to reduce the deficit, American workers would be much better off, tax revenues would be much larger, and the federal deficit would be much smaller. The recession would be much less severe.

If the Obama administration relies on stimulus and bank reform alone, the economy will fall back into recession once the spending has run its course. A pattern of false recoveries, much as occurred during the Great Depression, will likely emerge. Conditions will not be as bad, unemployment will stay at unacceptable levels.

This article was posted: Thursday, February 12, 2009 at 4:49 am





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