"A Note on Trade"

On emore from Tim Duy:

A Note on Trade, by Tim Duy: US trade data were released today; Calculated Risk has the broad outlines of the report. As Ryan Avent notes, the non-petroleum balance points in the direction of rebalancing. I am hopeful this is correct, but add that we still lack clear evidence at this point. Indeed, since the end of the recession, non-petroleum trade has generally been a drag on the recovery – note trend #1 below:

The rebalancing story took a hit in the first half of 2010 as the trade deficit widened. That situation reversed in the second half of 2010, and the narrowing deficit helped propel final demand in the fourth quarter of last year. Since then, the rebalancing story has stalled on average. Now it appears we are arguably at something of a crossroads – will the general path of the US trade deficit follow path #1 or path#2? In other words, will the external sector be a drag or US demand, or a boost? I am cautiously optimistic ongoing general downward pressure on the dollar, in concert with policy changes and solid growth abroad, will sustain ongoing rebalancing.

That said, rising expectations of tighter monetary policy abroad serve as a reminder that the external environment could turn nasty. From Bloomberg:

Commodities sank, with gasoline falling the most in two years, U.S. stocks slid and the dollar rose as concern over Europe’s debt crisis deepened and inflation reports spurred speculation global interest rates will rise…

…The pound rallied as Bank of England Governor Mervyn King said inflation remains “uncomfortably high” and officials signaled they may raise rates later this year. Price gains in Germany and China topped estimates and Poland unexpectedly increased its benchmark rate. Concern about Europe’s debt crisis and prospects for higher borrowing costs damped enthusiasm for stocks even as earnings improved at companies from Macy’s Inc. (M) to A.P. Moeller-Maersk A/S and U.S. exports climbed to a record.

Policy in China needs to tighten to stave off actual inflation. Optimally, Chinese policy steps, such as allowing the renminbi to rise at a faster rate, would shift demand internally toward consumption and away from the investment and export industries, effectively allowing US production to satisfy Chinese demand. This week's US-China talks give room for optimism on this issue. This is a reasonable policy path for other emerging markets as well and, in my opinion, the only win-win path. Still, it is not guaranteed that such a transition can occur smoothly, especially if inflation is already deeply embedded in the Chinese economy. A messy transition could slow global growth and put upward pressure on the dollar.

It is not clear that Europe, either the UK or Euro region, needs higher rates, but instead are being pulled in the trap of tightening policy in the face of a temporary commodity price shock. And it certainly seems clear that Ireland, Greece, and Portugal will be even more challenged to achieve fiscal and economic stability, guaranteeing a default or that euphemism for default, restructuring. The combination of higher interest rates and financial crisis should also prove to be dollar positive, thereby slowing the path toward rebalancing.

Of course, as Avent also notes, a complete rebalancing in which the overall US trade deficit falls to zero seems like an overwhelming challenge in the face of the US propensity for imported oil. Perhaps a more manageable trade deficit in non-petroleum products is the best we can hope for at this point.

In short, despite an improvement in the non-petroleum trade balance since the middle of 2011, rebalancing of the external accounts is not yet a certainty. Rebalancing continues to depend on the ability and willingness of the rest of the world to accept and manage the consequences of that rebalancing. Arguably, so far, so good, but the real tests may still be ahead.