With the ECB meeting and U.S. jobs data the key events of the week, it is understandable the August U.S. trade balance, due out Friday, is not drawing much attention. However, the combination of the growth differentials, favoring the U.S., and the strong dollar lead to some concerns that trade will act as a drag on GDP.
Last week, we learned that Q2 GDP was revised to 4.6% annualized rate. Many, like ourselves, expected the expected the upward revision to come from more recent data on consumer purchases of services. This was not the case. The drivers were fixed investment (revised to 9.5% from 8.1%) and export growth, which was revised (revised to 11.1% from 10.1%).
The U.S. trade balance has been remarkably steady. The most recent data is for the month of July, when the U.S. recorded a $40.5 bln deficit. The 12-month average is a deficit of $40.8 bln. The 24-month average is $40.95 bln. The consensus is for a $40.8 bln deficit in August.
U.S. exports have also been steady of late. In July, U.S. exports amounts to $134 bln. The 12-month average is $135 bln, and the 24-month average is $133 bln. The record high set last October of $143 bln was retested this past March. In January 2009, when Obama started his first term, U.S. exported almost $78 bln of goods and services.
In addition to the usual factors, like growth differentials and currency movements that economists usually focus on, there seems to be something else at work. The U.S. Chamber of Commerce brings to our attention that in 2012, the U.S. ran a trade surplus with the twenty countries for which there is a free-trade agreement. It appears to have done so last year as well, though the breakdown of service trade data is not yet fully available.
The U.S. is the third largest exporter of goods, behind China and Germany. However, it leads in service exports, with over $680 bln in 2013 and a surplus of $232 bln. However, as we noted before, the U.S. does not service foreign demand by exporting, but by producing locally and selling locally. The sales by affiliates of U.S. multinationals sell more than four times more goods/services abroad than the U.S. exports.
The U.S. direct investment strategy has advantages over the more traditional export-oriented approach. It allows companies to be more insulated from the vagaries of the foreign exchange market. It leads to technology and skills transfer that facilitates the development in a way that the export-oriented model cannot. It produces a network of common interests. The latest research suggests that low skilled jobs at foreign branches of U.S. companies compete with low-skilled jobs in the U.S.. However, high skilled jobs abroad, compliment employment in the U.S..
The issue many investors and policy makers are discussing is whether the dollar appreciation will adversely impact growth through the net export channel. The Federal Reserve real broad trade weighted measure of the dollar is updated at the end of the month. It finished last year near 84.96. As of the end of August, it was just below 85.70.
The dollar rose against all the major and emerging market currencies in September. The only exception, according to Bloomberg, is the Chinese yuan, which appreciated less than 0.1%. The broad trade-weighted dollar index likely increased between 3-4% here in September. U.S. imports and exports for the remainder of the year have largely been priced and ordered already. This helps illustrate that the price of money can adjust quickly, but trade flows not so much. Most helpful for U.S. exports is stronger world growth, not a weaker dollar.
Another part of the issue is the impact of a stronger dollar on inflation. The main channel here is import prices. The Cleveland Fed recently study concluded that the dollar's strength in itself is not likely to place much downward pressure on imported prices. However, it did argue that in the current environment, global inflation trends are a useful predictor of future domestic U.S. inflation.
This is to say that the low inflation in Europe and Japan helps account for what the Fed’s 2% target has been undershot for more than two years. We expect that the recent sharp decline in the yen will reinvigorate Japanese inflation which has been softening in recent months. While the euro area just reported a new decline in CPI (preliminary Sept reading), we think it too is close to a turn in the cycle.
In recent days, both NY Fed President Dudley and Chicago Fed President Evans talked about the dollar. Both comments were stated in a conditional way: If the dollar was significantly stronger than could impact inflation expectations and growth. They were hardly saying that the dollar had risen too much or that its recent strength was a cause of concern or a driver of policy. At the same time, it would not be surprising if the next Treasury report on the foreign exchange market cautioned Europe and Japan not to substitute currency depreciation for structural reforms.