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The spiraling costs of Uncle Sam's deficits
By Peter Morici

The US Commerce Department recently released figures reporting that the United States' current-account deficit for 2005 was US$804.9 billion, up from $668.1 billion in 2004. The current account is the broadest measure of the US trade balance. In addition to trade in goods and services, it includes income received from US investments abroad, less payments to foreigners on their investments in the United States.

In the fourth quarter, the current-account deficit was $224.9 billion, up from $185.4 billion in the third quarter. In the fourth quarter, the current-account deficit exceeded 7% of gross domestic product (GDP). The current-account deficit could easily top $1 trillion a year by the second half of 2006.

Separately, the Commerce Department has reported that retail sales were down 1.3% in February, indicating that a consumer pullback is beginning. The combination of slower-growing consumer spending and a widening trade gap will dampen US economic growth by mid-year. Real GDP growth will likely be about 3.8% in the first half and 3.3% in the second half.

Among US corporates, slower second-half growth will hit Ford and General Motors particularly hard. Consumers will become more value-conscious in vehicle selection, and this will play into the strengths of Asian, and in particular Korean, brands. Ford and GM are not well positioned with attractive, smaller and reliable vehicles in the value segments of the market. Among these companies' offshore brands, Mazda is best positioned.

Anatomy of the hemorrhaging current account
In 2005, the United States had a $1.6 billion surplus on income flows and a $58.0 billion surplus on trade in services. Even together, however, these were hardly enough to offset the massive $781.6 billion deficit on trade in goods.

The trade deficit for petroleum products was $229.2 billion last year, up from $163.4 billion in 2004, reflecting the fact that prices for imported petroleum had risen about 36% from 2004, while the volume of imports fell 2%. The US appetite for inexpensive imported consumer goods and cars was a huge factor driving the trade deficit higher. In 2005, the deficit on non-petroleum goods was $537.2 billion, up from $487.6 billion in 2004.

Imports of motor-vehicle parts increased 10% to $83 billion, as Ford and GM continue to push their procurement offshore and cede market share to Japanese and Korean companies offering vehicles that were better made and less expensive to own. Even when they assemble automobiles in the United States, Asian auto makers import more parts than Ford and GM do.

In addition, the Wal-Mart effect was broadly apparent. The trade deficit with China was $201.7 billion last year, a new record. This was up from $162.0 billion in 2004.

This situation is likely to become worse in the months ahead. Crude-oil prices are rising again, and an overvalued US dollar continues to keep imported cars and consumer goods cheap. Announced production cutbacks at GM and Ford will result in more imports of motor vehicles and parts.

Meanwhile, the dollar remains at least 40% overvalued against the Chinese yuan and other Asia currencies. China continues to peg its currency against the dollar. Although China revalued the yuan from 8.28 to 8.11 in July, and announced it would adjust the currency's value to a basket of currencies, the yuan continues to track the dollar very closely. Currently it is trading at 8.04.

Other Asian governments conform their currency policies to China's, lest they lose competitiveness in US and European markets. To sustain undervalued currencies against the dollar, foreign governments purchased $220.7 billion in US securities in 2005. This created an 11% subsidy on their exports to the United States.

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% higher in industries that export and compete with imports, and reducing the trade deficit and moving workers into these industries would increase GDP.

Were the trade deficit cut in half, GDP would increase by nearly $300 billion, or about $2,000 for every working American. Workers' wages would not be lagging inflation, and ordinary working Americans would more easily find jobs paying good wages and offering decent benefits.

Manufacturers are hit particularly hard by this subsidized competition. Through recession and recovery, the manufacturing sector has lost 3 million jobs. Following the pattern of past economic recoveries, the manufacturing sector should have regained about 2 million of these jobs, especially given the very strong productivity growth accomplished in durable goods and throughout manufacturing.

Longer-term, persistent US trade deficits are a substantial drag on growth. US import-competing and export industries spend three times the national average on industrial research and development (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 US investments in new methods and products, and skilled labor.

Cutting the trade deficit in half would boost US GDP growth by 25% a year. These effects of lost growth are cumulative. Thanks to the record trade deficits under President George W Bush, the US economy is about $1 trillion smaller. This comes to nearly $7,000 per worker.

Had the Bush administration and the Congress acted responsibly to reduce the trade deficit, American workers would be much better off, tax revenues would be much larger, and the federal deficit would be about half its current size.

Were the trade deficit cut in half, $2,000 would be recouped, but $5,000 per worker in lost growth is in essence lost forever. And the damage grows larger each month, as the Bush administration and the Congress dally and ignore the corrosive consequences of the trade deficit.

Peter Morici is a professor at the University of Maryland's Robert H Smith School of Business, and a commentator on economic and political issues.

(Copyright 2006 Peter Morici. Used with permission.)