Wrestling the US trade deficit downer

Tonight the Commerce Department is expected to report the deficit on international trade in goods and services was $42.8 billion in October, up from $41.5 billion in September.

The $500 billion annual trade deficit is a major drag on domestic demand, and will likely worsen in the months ahead. Together with a deal to slash the federal budget deficit that raises taxes and cuts government spending by a combined $250 billion, the trade gap could thrust the economy into recession again.

The US economy suffers from too little demand.

Consumers are spending, and the annual federal deficit has increased from $161 billion before the financial crisis to more than $1 trillion, injecting enormous additional demand into the system. However, too many of those dollars go abroad for Middle East oil and Chinese goods that do not return to buy US exports.

Businesses, pessimistic about future domestic spending net of imports, and facing rising employee benefit costs mandated by Obama Care and burdensome new regulations, are reluctant to hire in the United States. These have frustrated the virtuous cycle of temporary tax cuts and additional government spending, new hiring, and additional household spending that Keynesian stimulus was supposed to beget.

Now the nation faces a recession if budget negotiators substantially cut the federal deficit.

Imported oil and subsidised imports from China account for the entire trade gap. President Obama has talked repeatedly about developing the full range of energy resources, but maintained counterproductive limits on oil production in the Gulf, off the Pacific and Atlantic Coasts, and Alaska.

Development of new onshore reserves in the lower 48 states have not delivered enough new oil to cut imports in half, as is possible with a full push on US reserves, and the potential impact of electric cars and wind, solar and other alternatives is limited for at least the next decade.

To keep Chinese products artificially inexpensive on US store shelves, Beijing undervalues the yuan through intervention in currency markets. It pirates US technology, subsidises exports and imposes high tariffs on imports.

Beijing offers token gestures, knowing president Obama will not take the strong actions, advocated by economists across the ideological and political spectrum, to force China to abandon its mercantilists policies. It successfully cultivates political support for the American policy of appeasement among large US multinationals and banks doing business and profiting in the Middle Kingdom.

Cutting the trade deficit by $300 billion, through domestic energy development and conservation, and forcing China's hand on protectionism would increase GDP by about $500 billion a year and create at least 5 million jobs.

Longer term, large trade deficits shift resources from manufacturing and service activities that compete in global markets to domestically focused industries. The former undertake much more R&D and investments in human capital.

Cutting the trade deficit in half would raise US economic growth by 1 to 2 per cent. But for the trade deficits of the Bush and Obama years, US GDP would be 10 to 20 per cent greater than it is today, and unemployment and budget deficits not much of a problem.

Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist.

Follow Peter Morici on Twitter @pmorici1