Why the growing trade deficit matters

Via Hale Stewart (AKA Bonddad), Bloomberg News is reporting that the US trade deficit widened to a record $68 billion in July. It's pretty normal for busy Americans to read such depressing news in the paper, shrug their collective shoulders and shift their attention to more immediately pressing concerns. But the growing trade deficit is a serious problem with serious ramifications for our economy, and many experts don't think the issue is going to be resolved any time in the near future.

As Stewart notes: "Essentially, a trade deficit means the US is consuming more than it produces. To make up the difference between what a country produces and what it consumes, the country first draws down its savings. However, the US doesn't have much savings anymore. The US consumer's savings rate has been negative for the last year and the federal government is issuing over $550 billion in bonds every year. Corporations are the only sector that is saving money in the current economy."

The fact that savings are currently non-existant in the US these days has tremendous importance in terms of how the deficit will play itself out in the coming years. Without savings, in fact, the US is essentially forced to rely on foreign capital inflows to finance the trade deficit.

According to Stewart, at the levels announced last week, the US needs to attract $2.2 billion dollars a day in foreign inflows just to finance its trade deficit. And even though the US has been able to continually attract foreign funds for investment in the US in the last few years, we shouldn't assume this will last forever.

In his post, Stewart also points out that according to the IMF, the US has been "the beneficiary of a convergence of economic events that started with the Asian financial crisis of the last 1990s [. . .] This event made emerging markets less attractive for direct investment, therefore making more stable countries like the US more attractive for international investment. In addition, contrary to Bernanke's "global savings glut" theory, the primary reason for the excess savings in the world is a drop in Asian internal investment. Money the Asian economies would traditionally invest in their own productive capacity was freed to move offshore. Finally, the US economy has grown faster than Asia and Europe over the last 5 years, making the US the de facto most attractive place for the excess savings to flow."

However, there is a general consensus among economic forecasters that the US economy (GDP growth) will slow in the coming year. Not only would this slowdown not be conducive to attracting overseas investment, at the very same time there are quite a few "developing" economies around the globe that are growing at faster rates than the US - China, India, Russia, several Eastern European countries, Brazil and Mexico. According to Bonddad, "as US growth slows, these faster growing economies may receive a boost in foreign direct investment at the expense of the US."

Suffice it to say, that is not a good scenario for a country with a huge federal deficit and a growing trade imbalance, and the IMF is already expressing concern over the impact such imbalances may have on the world economy.