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The Economist: Balancing payments

By By Ray Perryman
March 31, 2012 at midnight
Updated March 30, 2012 at 10:31 p.m.


One of the more watched statistics in the realm of economics is the trade balance. For decades, the United States has run a trade deficit, meaning we are importing more than we are exporting.

The potential fallout from these trade deficits is a subject of heated debate, with a wide range of opinions regarding the level of danger such deficits pose as well as the ways they should be addressed.

Trade deficits are a major component of the balance of payments, which reflects a country's international transactions for a particular time period.

If a transaction causes money to flow into a country, it increases the balance of payments, while transactions that cause money to flow out decrease it. There are three major types of transactions.

First, there are exports and imports of goods and services (which are the bulk of the current account). Second, capital transfers and acquisition and disposal of non-produced, non-financial assets (such as sales/purchases to rights to natural resources or patents) comprise the capital account. The third category is the financial account which records investment flows (including both government and private assets).

In the United States, a deficit in the current account (because we import more than we export) is offset by surpluses in the capital and financial accounts.

In the fourth quarter of 2011, for example, Bureau of Economic Analysis data indicate that the current account deficit was $124.1 billion, up from $107.1 billion in the third quarter. While there are some other categories of transfers in the current account, the drivers, as noted, are imports and exports of goods and services.

A surplus in services of $45.3 billion partly offset the deficit in goods ($186.3 billion) for a total goods and services deficit of $141.1 billion for the fourth quarter.

At the risk of confusing things further, it's important to remember that the deficit in goods (surplus in services) is driven by both exports and imports. So when the deficit is up, it can be caused by either falling exports or rising imports (or both).

In the fourth quarter of 2011, most categories of goods exports were down, with a major cause being a drop in exports of certain types of metals. At the same time, imports of goods were up, with the largest increase being in capital goods (such as civilian aircraft, engines, and parts).

And why do we care? What difference does it make if we have a trade imbalance? There is no one and only correct response to such questions, and answers depend on everything from political leanings to forecasts of future economic performance. However, here are some important considerations.

It is true that running a perpetual trade deficit increases our debt and/or depletes our capital. When things are purchased from other countries, there must be some offsetting flows in the form of borrowing or sales of capital assets.

Our large trade deficits generally mean that we are borrowing from abroad, a situation which could become difficult to sustain if it gets out of hand. One school of thought says that it's already out of hand, and that a day of reckoning will come when foreign investors are no longer interested in financing our consumption.

However, even in the darkest days of the recent recession, the United States remained the safe harbor of choice, and as long as we get our fiscal act together, we should be able to avert a crisis.

Another argument you will frequently hear is that the big trade deficit is all because of oil imports and high oil prices. While petroleum is certainly a large category, it's not the big kahuna it once was.

In 1994, petroleum imports were about $172.1 trillion of total imports of $685.2 trillion (using a series of Census Bureau data which is in 2005 constant dollars to adjust for inflation). In 2011, petroleum imports were $210.6 trillion of a total of $1,787.5 trillion, a much smaller percentage. In addition, petroleum imports have fallen since the mid-2000s.

Looking at imports of goods by principal end-use category (again using the Census data which is adjusted for inflation), one big category of growth has been consumer goods, which rose from $143.2 trillion in 1994 to $483.1 trillion in 2011.

Capital goods are up even more, from $110.7 trillion in 1994 to $508.8 trillion in 2011. So it's not just petroleum, and it's not just consumer goods; some of the things we're importing also are helpful to future growth.

Turning to exports, the same dataset indicates expansion from $521.8 trillion in 1994 to $1,216.4 trillion in 2011. The biggest growth category is capital goods, up from $163.2 trillion in 1994 to $484 trillion in 2011.

Even so, growth in exports has not kept up with growth in imports, hence the widening gap and the largest current account deficit in the world.

Among countries on the other side of the equation - those with large surpluses - China is atop the list. This phenomenon is no surprise given the rapid growth in that country's exports as it has opened its economy and the fact that a large component of the Chinese population cannot afford imported goods.

Saudi Arabia is also near the top thanks to huge oil exports. However, Germany, Japan and Switzerland also tend to run huge surpluses.

Huge and growing trade deficits can certainly erode the stability of the U.S. economy over time. Encouraging exports is one way to improve the situation, and growing purchasing power in developing nations will help. Opening up markets through trade agreements is also important, as we need ever expanding markets for our sophisticated technological production.

Dr. M. Ray Perryman is president and chief executive officer of The Perryman Group (perrymangroup.com). He also serves as Institute Distinguished Professor of Economic Theory and Method at the International Institute for Advanced Studies.

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