The U.S. Trade Deficit Once Again

Dan Altman writes a good article on America's trade deficit:

A Stickier Trade Gap - New York Times: By DANIEL ALTMAN

Last year was the eighth in a row with a record-setting deficit in the nation's current account.... Yet once upon a time, that big deficit turned around, and it took a mere five years.... From 1987 to 1991, the annual current account deficit fell from a peak of almost $161 billion--equivalent to about 3 percent of the domestic economy--to less than $3 billion. This time, however, the challenge is bigger: the deficit of $805 billion for 2005 was about 6 percent of the domestic economy. And there are other factors that could make a turnaround much more difficult.

First, consider what took place in the late 1980's and early 1990's. The dollar was falling rapidly against foreign currencies, partly as a result of coordination by the governments of the world's five biggest economies. As the dollar fell, American investments became less attractive to foreign investors; the same returns would be worth less when converted into their home currencies. The returns themselves were falling, too.... But even if exchange rates change with the euro and Japanese yen, it probably won't solve the problem the way it did from 1987 to 1991. The big difference is the "changing shares of who we import from, and very few changes in who we export to," said Catherine L. Mann, a senior fellow at the Institute for International Economics, a research group in Washington. "It's important, because who we import from increasingly is from countries that have exchange rates that have not moved very much."

Back in 1987, the nation's current account deficit with Japan and Europe, which had fairly flexible currencies, was 62 percent of the total deficit. Last year, it was just 32 percent.... These changes matter, because countries like China protect their currency links by keeping plenty of dollar-denominated securities in reserve in their central banks. Private investors help out, too, and all those purchases of American securities keep the dollar's value relatively high. When the dollar's value drops relative to the euro and the yen, its exchange rates with the Chinese yuan and a bevy of other currencies don't follow suit.

Moreover, even if the economies of Europe and Japan picked up sharply, it might not help American exports as in the late 1980's. "Today, a really big boom for them is a lot smaller, because they've just slowed down so much in terms of their average growth rates," Ms. Mann said....

"The U.S. capital markets are where people want to invest their money right now," Professor Hodrick said, "and the performance of our economy has been really extraordinary, so there's no reason to think that that's a bad idea."...

Hodrick simply has not looked at the capital inflow data closely: there's little reason to think that true private capital flows to America are large right now. Dan should have probed more deeply--and brought up somebody like Marty Feldstein to rebut.

Me? I still think that a soft landing for the U.S.--either a gradual shrinkage of the deficit or a sharper move triggered not by U.S. macroeconomic distress but by a burst of inflation in Asia--is more likely than a hard landing. But we are well into the danger zone, and getting further in with each passing day.