It’s one of those things that just seem to take on an air of inevitability, like death, taxes and paparazzi pictures of Paris Hilton drunk with her skirt hiked up around her waist. After a while you just shrug your shoulders and take it to be the natural order of things. Yes, The United States has set yet another record in trade deficits, clearing the bar at an impressive $68 billion.
The U.S. trade deficit widened more than forecast in July to a record $68 billion as imports reached an all-time high and exports declined for the first time in five months.
The gap in goods and services trade follows June’s $64.8 billion shortfall, the Commerce Department said today in Washington. The increase in imports reflected record crude oil prices and more shipments of equipment, raw materials and consumer goods from overseas.
US trade deficit and impact of petroleum
(Click for larger image)
First off, it might be prudent to establish some terms. There are a couple of different deficits, which can be more or less related, depending on economic circumstances.
You have the straight up trade deficit. If a country exports goods and services for, let’s say, $1 billion per annum, but imports same to the amount of $1,2 billion, then that country would be running an annual trade deficit of $200 million.
Then there’s the current account deficit, which takes into account all movements of capital, not just trade. Let’s say a given country ran a trade deficit of $200 million. But private and public domestic actors owned a number of assets abroad, which yielded $150 million in profits, which were repatriated. Then the current account deficit would come out as $50 million
At last we come to the federal budget deficit, which is simply how much more the government spends than it takes in in taxes, excises and other sundry income. This deficit, at least in the question at hand, has somewhat of an influence on the trade deficit, and a profound one on the current account deficit, as The United States budget deficit is increasingly financed through the sale of debt instruments (with interest payments following) to foreign buyers, private and national.
One could of course say, and a number of reputable economists indeed do, that trade, current account and public purse deficits no longer matter as they once did in this “new” globalised economy. Unlike before, back in the age of the gold standard and its long Bretton Woods coda, when credit markets were mainly local, insular, and any excess government borrowing risked crowding out private loans, and thus throtling the domestic economy, and trade and current account deficits posed a direct and immediate threat to national solvency, states can now dip into an international credit market with a depth and liquidity of staggering proportions.
In 2002 Vice President Richard Cheney famously told then Treasury Secretary of The United States, Paul O’Neill, who was a bit worried about the growing budget deficit, that, “You know, Paul, Reagan proved deficits don’t matter.” Of course he probably meant that there was no political price to pay for said deficits. A month later he dismissed his old friend O’Neill from his post in the cabinet.
Ben Bernanke
But it’s hardly just political operatives who take the different deficits lightly. Before gaining his present lofty position of Federal Reserve Chairman, Ben Bernanke claimed that what we were dealing with was less a US deficit, than a global “savings glut”. Other parts of the world, such as the European nations, but mainly the Asian nations, and China in particular, were simply consuming too little, and saving so much that it made sense to utilise the cheap credit. And in some ways he did have a point.
With the creditor nations flooding the markets with liquidity, far higher debt burdens (both private and public) could be managed with total monthly interest payments staying the same, or even falling. With the quasi-Keynesian debt spending fuelling economic growth which outran monthly payments, for the time being at least, it seemed almost like free money.
The low interest rates also fuelled a booming housing market in the US. With lower monthly payments, people could afford to trade up for grander houses, or “take out equity” for spending money by refinancing their loans. This underpinned the economic growth, which has been 70% consumer driven, by masking the fact that wages were stagnant for large sections of the work-force.
Foreign holdings of US Treasury debt
(graph from The Economist)
Just as loose lending practises lead to consumers taking on too much debt, the same is true on a macro-scale in an environment where a government can finance deficits with all too much ease. A major lender in recent years has been the Chinese central bank, having been handed the relay stick by former credit champion of the world, Japan. Now, aside from the strategic and political qualms the US may or may not have about China holding such massive amounts of US debt instruments, they are bound in a curious love-hate relationship with the Chinese economy in general, and Chinese currency policy in particular.
In general China produces the cheap goods that produce everyday big profits for US companies such as Wal-Mart, and they export wage deflation to the US and other industrialised countries, helping keep wages of workers in those countries at or below the rate of price inflation, in a paradoxical reverse colonial trade pattern that shifts capital and raw materials out of the imperial centre and manufactured goods back in.
On the other hand China produces cheap goods that decimate domestic manufacturing in the US and other industrialised countries, and export wage deflation, which pisses off workers in those countries to no end.
When it comes to currency policy in particular, China intervenes in the market, keeping their currency, the Yuan, at an artificially low exchange rate, to boost their exports. This has a negative effect on US and other nations’ domestic manufacturing and export sectors. But, this intervention, buying up US bonds, is also what keeps US interest rates down, and fuels the housing bubble of recent years, and refinancing of said housing at lower rates, leaving consumers with more money to consume, as well as allowing the federal government to run deficits with little obvious pain. The status of the US dollar as the world’s reserve currency, the thing people the world over traditionally have squirrelled away in their mattresses in times of trouble, with numerous other currencies tied to it in more or less formal ways, and all countries being forced to have it on hand to buy their oil, has also been an enormous shock absorber for economic stresses.
Some economists have fretted that international lenders would do the job of the Federal Reserve Chairman, and take away the punch bowl. But thus far any inclination in that direction has failed to materialise. In fact, for the time being, they seem willing and able to finance even larger infusions of capital into the US to cover the various deficits that country is running.
Historically one has to go back to 1780s France to find an example of a major power laying on debt at a simillar rate in peacetime. That of course did not end entirely satisfactorily.
In 1987 history professor Paul Kennedy published the work “The Rise and Fall of the Great Powers”. One of the central themes of that book was that great powers usually start out as economic power houses. Trade brings riches to the nation. The over seas trading routes must be protected by a navy. Trading interests in other nations bring with them real, or perceived, obligations to be answered with armed forces. What might have started out a commercial republic, turns into an empire.
But after a while the rising cost of maintaining that empire starts to divert funds away from new investment infrastructure, reasearch and development and manufacturing. Little by little the economic foundation the power rests upon is whittled away. Lower cost competitors start to grab market share, not only abroad, but even in the imperial heartland. Capital starts to flow out of the imperial centre instead of in.
Now, at this stage one could say that the logical course of action would be to scale back military expences and divert much needed funds towards investment. But by this time the military-industrial complex has become entrenched. Patronage, fortunes and established interests are bound up with the mechanics of empire, as well as not a little national pride.
Instead great powers seeing their economic dominance slipping tend to spend even more funds on the armed forces, which by now seems their greatest advantage, to shore up their international position, furter weakening the economic base. The trend line of economic growth rises, and then flattens out. While the line representing military might lags behind, making, in the end, a sausage shaped patern.
10 years after the publication of “The Rise and Fall of the Great Powers”, at the start of the great dot.com boom, which seemed to put any fears of economic decline to rest, Kennedy wrote in Atlantic Magazine:
The United States now runs the risk, so familiar to historians of the rise and fall of Great Powers, of what might be called ‘imperial overstretch’: that is to say, decision-makers in Washington must face the awkward and enduring fact that the total of the United States’s global interests and obligations is nowadays far too large for the country to be able to defend them all simultaneously.
Since that time “The Global War on Terror” and the wars in Afghanistan and Iraq have led to a massive growth in military expenditure. Federal budget deficits have ballooned. And trade and current account deficits have shot up. US national debt now stands at $8.5 trillion, with interest rates, and interest payments, rising.
