Stock prices and the trade deficit
By Peter Morici
web posted November 12, 2007
Wall Street and American capitalism are suffering a crisis of confidence. Stock markets are in turmoil, because U.S. banks are taking record losses from foolish bets on subprime mortgages, the dollar is tanking against the euro and some other currencies, and oil prices are rocketing.
The U.S. trade deficit is at the center of this mess.
Since December 2001, the trade deficit has more than doubled, and for the last 38 months, it has remained above $50 billion. This gap must be covered by foreigners investing in U.S. businesses or foreigners buying U.S. bonds, collateralized debt obligations, or other paper assets.
The foreign appetite to invest in controlling interest of U.S. enterprises is no more than $10 billion a month, especially when the U.S. economy is growing at less than 4 percent and China and India are cracking along around 10 percent. Hence, Americans have been borrowing more than $40 billion a month, and have amassed a $6 trillion foreign debt to finance these trade deficits.
Foreign central banks, led by China, Japan, India, South Korea, and Brazil have been major takers of U.S. paper, because private foreign lenders simply are not willing to soak up all this debt.
The recent failings of mortgage bankers, investment and commercial banks, bond rating agencies, and even private equity -- Cerberus owns the biggest loser in the subprime debacle, General Motors Acceptance Corporation -- are causing private investors, and some central banks, to sell off American paper and send the dollar and stock prices south.
The sinking dollar against the euro and the pound does help boost U.S. exports, because American and European businesses, from Airbus and Boeing to French and Wisconsin cheese, compete for global markets. However, the monthly trade deficit remains close to $58 billion a month, because petroleum, consumer goods from China and automotive products account for about 98 percent of the trade deficit.
Oil is priced in dollars. A falling dollar drives up petroleum prices and the oil import bill, because a cheaper dollar permits foreign consumers, who earn their incomes in other currencies, to aggressively bid up the price. No surprise, oil heads past $100 a barrel.
Retuning conventional gasoline engines, hybrids, nuclear power, and alternative energy sources could substantially reduce oil consumption. These solutions require national leadership, but both Republican and Democratic Parties have failed to champion comprehensive policies to accomplish what is possible. Don't hold your breath waiting.
The Peoples Bank of China has stepped up purchases of foreign currencies to keep the yuan, and its exports to North America and Europe, cheap. In 2006 those purchases came to $248 billion, and in 2007, seem headed for $500. China is lending America and the world 16 percent of its GDP, and subsidizing its exports to the tune of 45 percent.
Automotive products contribute about $10 billion to the monthly trade deficit. Mexico and Canada account for $3.6 billion, reflecting the cross-border supply chains of the Detroit automakers. Those production decisions change only slowly.
German automakers account for $1.7 billion of the trade deficit, but those cars are mostly higher-priced models within their vehicle classes. As prices rise, volumes fall only gradually and the total cost of German imports don't change much with exchange rate movements.
Japanese and Korean automotive products account for $4.7 billion of the deficit, and a large share face fierce price competition. Having production facilities in the United States, Asian manufacturers could move more production here. However, following China's lead, the Banks of Japan and Korea have aggressively stepped up purchases of foreign currencies to keep the yen and won cheap and discourage Toyota, Hyundai and others from moving much more auto assembly and parts purchasing to the United States.
It is fashionable to tag the U.S. federal budget deficit for these purchases, but this deficit is little more than $16 billion a month. Currency manipulation is not about funding U.S. federal spending, it is about boosting exports to the United States.
Last Friday, the Commerce Department released data for the September trade deficit. The preliminary estimate for the August deficit was $57.6 billion, and most forecasters expect the September number to be larger.
Preliminary data indicate it is a tough call for the prognosticators. Departments of Energy and Commerce data indicate that the price of imported oil rose in September but volumes were lower. Auto sales are retreating but the Asians are doing better than the Detroit Three. Meanwhile, imports from China could take a hit thanks to flagging holiday sales and the safety scare.
The fall in the dollar against the euro gave U.S. exports a boost, showing exchange adjustments can have their intended effects on the trade deficit. However, until the United States does something about its appetite for oil and China and other mercantilist states stop manipulating their currencies, the United States will continue to have large trade deficits, and that won't be good for foreign confidence in the U.S. economy or the dollar.
Clean up the subprime mess and solve the trade deficit, and U.S. equities will zoom. Sadly, neither Treasury Secretary Henry Paulson nor Federal Reserve Chairman Ben Bernanke have said a lot about either problem that inspires confidence. That is why stock prices are so vulnerable. 
Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.