MONEY MATTERS: Trade Deficit Reaches Historic Proportions

U.S. Trade Deficit Sets Fifth Consecutive Record

It has many economists worried. It has politicians worried. We’ve been warned of the resulting dangers. And still it gets bigger and bigger.

Last month, the Commerce Department announced that the U.S. trade deficit set a record for the fifth consecutive year in 2006. And for the first time, the U.S. even ran a deficit on investment income.

To measure the current deficit, the Commerce Department used the broadest measure of trade, which covers not only trade in goods and services but also investment flows between countries. The current deficit also represents the amount of U.S. assets that have been transferred into foreign hands to cover the gap between American exports and imports.

And the imbalance has become staggering; it shot up 8.2 percent to $856.7 billion, representing a record 6.5 percent of the total U.S. economy. What it all means is that the United States was borrowing more than $2 billion a day to finance its trade gap.

Trade deficits are nothing new in the U.S. In fact, the U.S. has run deficits in the trade of goods every year since 1976. But this time the news is different.

The flow of investments into the U.S. turned negative by $7.3 billion, from a surplus of $11.3 billion in 2005. It marked the first time on record that investment income has been negative, going back to 1929. In simple terms, foreigners earned more on their U.S. holdings than Americans earned on their foreign investments.

The reason for this sudden downturn? Well, actually, it isn’t so sudden at all. It’s been about thirty years in the making.

For three decades America has gone into hock to foreigners through the purchase of consumer electronics, cars, clothing and other goods. In return, foreign governments have been more than willing - so far, at least - to hold American assets such as U.S. Treasury securities and U.S. corporate stocks, among other investments.

But some economists fear the possibility that U.S. investments could fall out of favor with these governments. If that were to occur, the value of the dollar would plunge, stock prices would crash and interest rates would soar. Ultimately, if U.S. investments fall out of favor with foreigners the country could be pushed into a recession.

The concern of many is that too much of our economic security has been, and continues to be, transferred into the hands of countries like Saudi Arabia, China and Japan, all of whom hold enormous amounts of U.S. government bonds and other assets.

For example, China has finally decided to diversify its huge and steadily growing foreign-exchange reserve by investing in overseas markets other than just the U.S. The move is a dramatic departure from its current practice of putting most of its eggs into one basket - US Treasury bonds.

The Chinese government announced it will set up a state-owned company to invest its $1 trillion foreign-exchange reserve in various overseas markets. That will leave the U.S. with less money to borrow – at least from China.

While much of the trade deficit is a reflection of the high price of imported oil, a weaker dollar has done little to help U.S. exports in the last couple of years. But, at last, that now appears to be changing. The weaker dollar is finally making the price of U.S. products more affordable in foreign markets. Some economists think the deficit may actually shrink this year, though marginally, for the first time since 2001.

That may help a little, but there’s still a long way to go. The break-even point in trade won’t be reached for many years – if ever.

In the meantime, the trade deficit has helped make the U.S. the world’s biggest debtor nation. As a result, the U.S. has to import $2.3 billion every day to finance its debts. Our government’s current and future obligations are now so large that they amount to half a million dollars for each U.S. household.

The truth is, America doesn’t make as much “stuff” as we used to, leaving a lot less for other nations to buy. Instead, we buy from them. That pattern may be unsustainable.

Remember the good old days of “Made in the U.S.A.”? Those days are mostly a memory now, and if you’re not old enough to remember when that actually meant something, then it doesn’t even amount to that.

Sean M. Kennedy, Money Correspondent:

Money Matters, by Gather Correspondent Sean M. Kennedy, is published every Thursday to Gather Essentials: Money.

Money Matters is a practical look at money and how developments in the American economy may affect you.

Sean is a freelance writer based in Los Angeles.

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