Econ Edge: The Economic Week
March 7, 2005 -- -- This week we'll see several reports from the Federal Reserve as well as speeches from Chairman Alan Greenspan and Governor Ben Bernanke.
On Friday the Department of Commerce will release the trade balance figures for the month of January. Recently, the trade balance has hit record highs, but as the dollar has weakened, this figure has slowly started to recede. That said, the trade gap with other countries is enormous as the United States continues to import vastly more than it exports.
To help us understand the significance of the trade deficit and how it affects the U.S. economy, we asked Robert Hormats, vice chairman of Goldman Sachs (International) to sort through the issues.
ABC: What is your forecast for the January trade balance to be released on Friday? Why does it continue to remain so high and how is it affecting the overall U.S. economy?
Hormats: Forecast for January Trade Balance -- $56.8 billion, basically unchanged from the month before. For the year as a whole, we are projecting a deficit of at $725 billion as opposed to $665 (billion) for 2004.
The deficit is high because the United States is growing more rapidly than most of its major trading partners. Western Europe's rate of investment is low so it is not importing a lot of capital equipment from the United States compared to the 1990s. Furthermore, oil imports remain high and China continues to become more competitive. Finally, we have not yet seen significant benefits from the lower dollar.
ABC: With the trade balance so large, what impact is it having on the U.S. dollar? When the dollar is weak against the currencies like the euro and the Chinese yuan, what does that mean to the average American?
Hormats: The effect on the U.S. dollar is to weaken it over time. Large imbalances raise concerns among dollar holders that the currency will have to adjust downward to boost the competitiveness of U.S. goods versus those of other countries. Other means of doing this are higher growth abroad than in the United States; however, growth in Western Europe and Japan is currently slower than in the United States. A big slowdown in the United States would also reduce the U.S. trade deficit because it would slow demand for foreign products. If that were to occur, it would affect the economies of other countries so their imports of U.S. goods would slow as well.
A weaker dollar means that Americans have to pay more for goods, meals and hotels when they travel abroad. And over time as foreign prices adjust, Americans in the United States will have to pay more for imported goods such as French wine as the result of a stronger euro or Japanese electronic products as the result of a stronger yen.
ABC: With all the talk about deficits -- federal deficits, Social Security deficits, trade deficits -- how important are they? Is their impact "negative" or "positive" for the U.S. consumer?
Hormats: These big imbalances are manageable in the short run, but troublesome over the long run if they persist or become larger. We are building up large debt obligations to the rest of the world.
Several years ago, much of the foreign money that came into the United States was supplied by private investors buying companies, stock or corporate bonds -- and therefore it boosted the productive side of the U.S. economy. Now much of it comes from foreign central banks and goes not to finance the private sector, but instead to finance the U.S. budget deficit: foreigners now are buying over half of new U.S. Treasury issues -- and hold over 43 percent of all Treasury bills, notes and bonds. The United States has to pay interest on these holdings, so gradually more and more of our GDP will be transferred abroad not to buy goods or services, but to pay interest on the federal debt to foreign central banks. Theoretically, that can continue for a long time, but what if some shock causes foreign investors to stop buying U.S. dollar assets or dump the assets they hold?
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