Global: The Paradox of Trade
- A sharply diminished US industrial base places major constraints on the potential upside of any trade-induced multiplier effects that may arise from a depreciation of the dollar. There is nothing new to this erosion -- it has been a constant trend evident over most of the post-World War II era. But it is particularly important to scale the size of the US manufacturing base relative to that of the mid-1980s -- a point in time when the major countries of the world endorsed the so-called Plaza Accord, which was aimed at pushing the dollar sharply lower. Back then, the ensuing currency adjustment did provide some unmistakable benefits to the US -- namely, a marked pick-up in export growth and a related narrowing of the trade and current account deficits. US exports increased at an 11% average annual rate over the 1986 to 1990 period and the trade deficit narrowed enough to push the current account actually into surplus briefly in 1991. But, today, with America's manufacturing base about 40% smaller than it was in the mid-1980s -- measured both by jobs and labor income generation -- its potential for sparking a revival in aggregate economic activity is likely to be commensurately smaller.
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Global: The Paradox of Trade
Stephen Roach (New York)
The dollar is topic du jour in world financial markets. While there was a sharp reversal in the US currency last week after an unrelenting bout of selling since early October, the case for a weaker dollar remains very much intact, in my view. It is central to what I have called global rebalancing -- the shift in relative prices that an unbalanced global economy needs in order to establish a more sustainable equilibrium. I have stressed from the start, however, that dollar depreciation can't do the job alone. That point bears further elaboration.
The United States has a serious and worrisome current-account deficit problem -- an imbalance that hit a record 5.7% of GDP in mid-2004 and that, by our reckoning, seems likely to widen further to at least 6.5% over the next year. Fully 92% of America's current account deficit shows up in the form of a trade gap on goods and services -- a shortfall that also hit a record of $623 billion (annualized) in the third quarter of this year. Currency fluctuations can have an important impact in shaping a nation's competitive position. For that reason alone, many believe that a weaker dollar will boost US exports and inhibit imports -- thereby resulting in a sharp narrowing of America's trade and current account deficits. This conclusion has also formed the basis of the belief that a weaker dollar will spur an important shift in the mix of US growth -- bringing output and jobs back home in a fashion that will establish a more solid base for domestic income generation. These conclusions may be wishful thinking.
Trade is the glue of globalization. And there can be no mistaking the explosive growth of global trade since the late 1980s. The ratio of global trade to world GDP rose from 17% in 1986 to a record 27% in 2004, according to IMF estimates. Over that 18-year period, growth in world trade volumes averaged 6.3% per annum, well in excess of the 3.5% average pace of world GDP growth. Not surprisingly, this surge in trade has provided a disproportionate benefit to low-cost manufacturers in the developing world. This has come at the expense of the high-cost developed world. While the US remains the world's largest exporter with an 11.1% share of total global exports of goods and services in 2003, its portion has been declining over the past several years. In fact, in 2004, America's average share of exports and imports, combined, fell to 13.2% -- down sharply from nearly 16% in 2000 and the lowest such portion since 1982. With America's share in global trade on the wane, it would certainly be an uphill battle for the US to trade its way out of its current-account conundrum.
The arithmetic of America's trade imbalance makes a currency-induced turnaround all the more daunting. The main reason is that US imports are currently 53% larger than exports. That means export growth has to be roughly 50% faster than import growth just to hold the trade deficit constant. Or putting it another way, if export growth was to surge and hold at double the pace of import growth, it would take about 10 years for the US trade deficit to be eliminated. Two conclusions follow from such calculations: First, the United States is unlikely to export its way out of its trade quagmire by a currency-induced improvement in competitiveness; with globalization pushing the US share of global trade down to the low end of historical experience, such an export-led resurgence seems highly unlikely. Second, the only real hope for meaningful improvement on the trade front over the next several years is on the import side of the equation; given the secular shift of rising import penetration into the US, that would undoubtedly require a protracted slowing of US domestic demand growth. More about that later.
But there is another important twist to this story. To the extent that output can be brought back home by a narrowing of the US trade deficit, job creation and income generation would potentially get a new assist. Such impacts could then spread to the economy at large through classic "multiplier effects" -- in effect, broadening the base of domestic demand support. This would be welcome news for a saving-short US economy that has turned increasingly in recent years to asset-based saving as a new means to support private consumption. It would also be an encouraging development for US businesses and investors -- potentially boosting market share at home and abroad and sparking related improvements in corporate profitability and equity prices.
Such a transformation may be a real stretch. In large part, that's because of the secular erosion of the US manufacturing base -- suggesting that today's US macro economy is likely to get a much smaller bang for its export buck than was the case 20 years ago. The evidence is compelling in this regard: At present, the manufacturing sector employs only 13% of all private sector workers in the US (10.9% if the government is included); that's far short of the 22.4% share of private industry payrolls prevailing in February 1985 -- the last time the US embraced a conscious policy of dollar depreciation. At the same time, the manufacturing sector of total wage and salary disbursements has plunged to just 14.1% in October 2004 -- down sharply from the 23.6% reading of February 1985. To some extent this is a productivity story -- US companies getting more out of less; indeed, manufacturing productivity growth has surged at an average 3.5% annual rate since 1987. But it also reflects, most importantly, a secular decline of factory sector output as a share of aggregate economic activity; in 2003, manufacturing value-added stood at just 13.6% of total value added for the US -- down sharply from the 18.9% share of 1985.
The macro conclusions from these trends are inescapable: A sharply diminished US industrial base places major constraints on the potential upside of any trade-induced multiplier effects that may arise from a depreciation of the dollar. There is nothing new to this erosion -- it has been a constant trend evident over most of the post-World War II era. But it is particularly important to scale the size of the US manufacturing base relative to that of the mid-1980s -- a point in time when the major countries of the world endorsed the so-called Plaza Accord, which was aimed at pushing the dollar sharply lower. Back then, the ensuing currency adjustment did provide some unmistakable benefits to the US -- namely, a marked pick-up in export growth and a related narrowing of the trade and current account deficits. US exports increased at an 11% average annual rate over the 1986 to 1990 period and the trade deficit narrowed enough to push the current account actually into surplus briefly in 1991. But, today, with America's manufacturing base about 40% smaller than it was in the mid-1980s -- measured both by jobs and labor income generation -- its potential for sparking a revival in aggregate economic activity is likely to be commensurately smaller.
Consequently, a weaker dollar is hardly the final answer to America's macro conundrum. It does, however, have the potential to be an important trigger for a series of related adjustments that would go a long way in addressing the basic problems of a saving-short US economy. The key is the link between the dollar and interest rates -- and the likelihood that dollar depreciation triggers a rise in real US interest rates. That, in fact, is a time-honored characteristic of a classic current account adjustment. In my opinion, it's especially likely in the present climate, as America's creditors -- heavily overweight dollars -- ultimately demand compensation for taking sustained currency risk. In the end, higher real interest rates may well be the only means to restrain the excesses of US domestic demand. But that's exactly what it will take to bring all the pieces of the US rebalancing puzzle into play -- redu
ced imports, a narrowing of gaping trade- and current-account deficits, and an improvement in domestic saving.
There is a certain irony in the adjustments that now lie ahead for the United Sates. The excess consumption of the Asset Economy is heavily dependent on the interest-rate subsidy provided by America's foreign creditors. Dollar depreciation challenges the sustainability of that subsidy. It also puts pressure on the underpinnings of asset markets that are so heavily dependent on interest rates. However, a weaker dollar is unlikely to spur a trade-induced renaissance of US industrial activity that might otherwise compensate for a shortfall in domestic demand. Therein lies the ultimate paradox of trade: Courtesy of a strong dollar and cut-rate foreign financing, America has been living beyond its means for almost a decade. As the dollar now weakens, that movie is about to run in reverse.
2004 Morgan Stanley
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