Trade Deficit, Interest Rates and Dollar

Dr. Rajeev Dhawan

Director ECONOMIC FORECASTING CENTER Prepared for International Business 8190 General Classroom Bldg. 327 September 7 th , 2005

Office: 404-651-3291 email: forecast@gsu.edu

http://www.robinson.gsu.edu/efc

The G ood, the Bad, and the Ugly

Sector or Area Construction Tax Collections Real Dividend Growth Bank Loan Activity Corporate Revenue Growth Health/Finance/Insurance Jobs Grade A++ A+ A+ A+ A A Weak Dollar (Earnings) Overall Job Growth B+ B+ Euro Zone Malaise Oil Prices Benefit/Health Costs Manufacturing Jobs Auto Over-Capacity Iraq/Terrorism Overall US Economy C C D D F F A -

Trade Deficit: Should We Worry?

(Bil. $) 0 -200 -400 -600 -800

Almost 6% of GDP!

-1000 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

5 (%)

The World’s Growth Imbalance

UNITED STATES GERMANY JAPAN

2 1 4 3 0 -1 2001 2002 2003 2004 2001 2002 2003 2004 2001 2002 2003 2004 Real GDP Net Export Contribution Source: Global Insight, EFC

(Bil. $) 200 Federal Budget, Trade Deficits and US dollar trade-weighted exchange rate Index 2000 = 100 140 130 0 -200 -400 -600 120 110 100 90 80 -800 1976 1980 Budget Deficit 1984 1988 Trade Deficit 1992 1996 2000 2004 U.S. Dollar Exchange Rate 70

Today’s Special: Conundrums

Why Haven’t Record Trade-Deficits Produced a Dollar Meltdown?

Why is the 10-Year Rate Falling Despite the FED’s 8 Rate Hikes?

Why Hasn’t Housing Moderated?

High Trade Deficit Numbers Keep US Long Term Bond Rates Low Which Fuels the Housing Boom!

NIPA Definition of GDP

Y=C+I+G+NX

Y = GDP C = Consumption I = Investment G = Government Purchases NX = Net Exports = Exports-Imports

Exports Share (%) 12 10 8 6 4 1963 1968 1973 1978 1983 1988 1993 1998 2003

Imports Share (%) 16 14 12 10 8 6 4 2 1963 1968 1973 1978 1983 1988 1993 1998 2003

Net Exports (%) 2 0 -2 -4 -6 1963 1968 1973 1978 1983 1988 1993 1998 2003

Savings and National Income Math

 GDP has been defined as: Y = C + I + G + NX  Rearranging terms gives: Y - C - G = I + NX  The left-hand side, which is the nation's income (GDP) leftover after consumption and government spending, is defined as

National Savings

"S": S = I + NX

Savings and National Income Math

 Trade Deficit (NX) =Net Capital Outflow (NCO) – If NX >0 implies lending abroad – If NX<0 implies borrowing from abroad   S=I+NCO S+{-NCO}=I – Investment= Domestic Savings +Net Capital Inflow

Net Foreign Investments and US Trade Deficit (Annualized and Smoothed) ($. Bil) 0 -100 -200 -300 -400 -500 -600 -700 ($. Bil) 0 -100 -200 -300 -400 -500 -600 93 94 Inv estments 95 96 97 98 Trade Deficit (Right) 99 00 01 02 03 04 -700

Chairman Alan Greenspan

TRADE DEFICIT

March 10 th , 2005

“Through much of the post-World War II years, domestic saving for each country was invested predominantly in its domestic capital assets, even when there existed the potential for superior risk adjusted returns from abroad. … But in the early 1990s, "home bias" began to diminish appreciably , and, hence, the dispersion of current account balances among countries has increased markedly.” “It is evident that the greater the degree of international flexibility, the less the risk of a crisis.”

International Trade Balance (2004)

Country

Canada Euro Area Mexico Japan United Kingdom China Germany Korea Netherlands Taiwan France Australia

Exports

190.2 127.1 110.8 54.4 36.0 34.7 31.4 26.3 24.3 21.7 21.2 14.3

In Billions of Dollars Imports

255.9 210.1

Net Balance

-65.8

-82.9 155.8 129.6 46.4 -45.1 -75.2 -10.4 196.7 77.2 46.1 -162.0 -45.9 -19.8

Their Current a/c as % of GDP 2.9% 0.8% -1.2% 3.4% -2.0% 2.4% 4.4% 3.1%

12.6 34.6 31.8 7.5 11.7 -12.9 -10.6 6.7

2.9% 6.9% -0.6% -5.3%

Governor Ben S. Bernanke

TRADE DEFICIT

March 10 th , 2005

“Essentially by definition, in each period U.S. net foreign borrowing equals the U.S. current account deficit, which in turn is closely linked to the imbalance in U.S. international trade.” “…inadequate U.S. national saving is the source of the current account deficit must be true at some level; indeed, the statement is almost a tautology.” “I see as the emergence of a global saving glut in the past eight to ten years.” “As a consequence of high desired saving and the low prospective returns to domestic investment, the mature industrial economies as a group seek to run current account surpluses and thus to lend abroad.” “…global supply of saving is the recent metamorphosis of the developing world from a net user to a net supplier of funds to international capital markets.”

Global Current Account Balances (Billions of U.S. Dollars) Countries Industrial United States Japan Euro Area France Germany Italy Spain Other Australia Canada Switzerland United Kingdom 1996 46.2

-120.2

65.4

88.5

20.8

-13.4

39.6

0.4

12.5

-15.8

3.4

21.3

-10.9

2003 -342.3

-530.7

138.2

24.9

4.5

55.1

-20.7

-23.6

25.3

-30.4

17.1

42.2

-30.5

Countries Developing Asia China Hong Kong Korea Taiwan Thailand Latin America Argentina Brazil Mexico Middle East and Africa E. Europe and ex-USSR 1996 -87.5

-40.8

7.2

-2.6

-23.1

10.9

-14.4

-39.1

-6.8

-23.2

-2.5

5.9

-13.5

2003 205.0

148.3

45.9

17.0

11.9

29.3

8.0

3.8

7.4

4.0

-8.7

47.8

5.1

Source: Remarks by Governor Ben S. Bernanke, March 10, 2005

The Bill Gross View

“ The Fed controls short rates. Intermediate and long rates are determined by institutions, individuals and foreign central banks, such as China’s, which have been massive buyers of Treasuries .” - Bill Gross Founder and Chief Investment Officer Pimco, Newport Beach, Calif.

Source: Barron’s, January 19, 2004

How China Runs the World Economy

EXPORTS:

$94.5 (16.2%)

IMPORTS:

$40.9 (7.4%)

EXPORTS:

$72.3 (12.4%)

IMPORTS:

$88.9 (16.1%)

EXPORTS:

$25.7 (4.4%)

IMPORTS:

$57.4 (10.4%)

Hong Kong EXPORTS:

$45.6 (17%)

IMPORTS:

$14.6 (5.3%)

Japan EXPORTS:

$122.3 (22.7%)

IMPORTS:

$56.3 (14%)

EXPORTS:

132.9 (22.8%)

IMPORTS:

42.5 (7.7%)

S. Korea EXPORTS:

$44.6 (17.8%)

IMPORTS:

$27.2 (12.7%)

EXPORTS:

$23.3 (4.0%)

IMPORTS:

$29.8 (5.4%)

Germany EXPORTS:

$78.6 (8.8%)

IMPORTS:

$46.6 (6.5%) Source: CIA Fact book

Country Japan United States Hong Kong South Korea Taiwan Germany Malaysia Singapore Russia Netherlands

TRADING GIANT

Export Import Deficit/Surplus Total Trade ($. Billions) 133.5

126.5

87.4

63.2

58.4

41.7

20.1

19.4

15.7

15.4

59.4

33.9

11.1

43.1

49.4

24.3

14.0

10.5

9.7

1.9

74.1

92.6

76.3

20.1

9.0

17.4

6.1

8.9

6.0

13.5

- 14.7

58.7

65.2

- 23.0

- 40.4

- 6.9

- 7.9

- 1.6

- 3.7

11.6

China Taiwan Hong Kong Singapore Germany Trade and Holding of US Treasuries by Central Banks Trade in Goods and Services As of 2004 Change U.S. Treasury Securities Holdings As of 2004 Change Currency Appreciation -162 -12.9

6.5

4.3

-45.8

-38.1

1.2

1.8

2.9

-6.6

196 59.1

52.9

26.9

59.5

49.4

18.2

22.7

4.1

19.5

0.0

6.7

0.0

4.1

8.0

In one year Japanese Bought $350+ Bil. worth of Treasuries to Keep their Currency from Appreciating

* All numbers are in billions of U.S. dollars

Source: BEA (Trade) and US Treasury Department

Net Foreign Purchases of U.S. Financial Instruments ($. Bil) 500 400 300

Global Savings Glut Is Showing up in T-Bond Holdings

Corp. Bonds T-Bonds 200 100 0 -100 Stocks Agency -200 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04

Source: FRB Flow of Funds Data

Dollar Depreciation Against Yen and Won Since January 2004 (%) 20 15 10 5

Korea is the Loser in this Battle

Won 0 -5 Yen -10 JAN 2004 FEB MAR APR MAY JUN JUL AUG SEP OCT NOV DEC JAN 2005 FEB MAR APR MAY

2004 US Balance in International Trade

What We Buy From Them

Crude Oil -135.7

Vehicles Clothing Home Electronics Office Electronics Petroleum Preparations Furniture and Bedding Natural Gas Electrical Machinery Toys, Sporting good -123.2

-67.9

-67.8

-65.6

-28.3

-23.7

-21.1

-20.2

-19.1

What They Buy From Us*

Airplanes 13.2

Chemicals (Plastic) Airplane parts Soybeans Corn Wheat Scientific Instruments Cotton Metal ores Animal Feeds 10.9

10.5

6.6

6.0

5.0

4.5

4.2

3.2

3.0

* Billions of Dollars

Source: US Bureau of Economic Analysis

2002 Passenger Car Production and Sales Country

Japan Germany U.S.

France S. Korea Spain Brazil U.K.

Canada Mexico China India Sweden

Production

8,117,563 5,301,189 4,879,119 3,181,549 2,471,444 2,211,172 1,495,622 1,492,365 1,274,853 1,000,715 703,521 573,808 251,035

Sales

4,289,683 3,341,718 8,422,625 2,254,732 1,065,161 1,437,192 1,295,119 2,458,769 868,188 667,565 780,604 601,321 246,581

Deficit /Surplus

 

3,827,880 1,959,471 -3,543,506 926,817 1,406,283 773,980 200,503 -966,404 406,665 333,150 -77,083 -27,513 4,454

Source: Ward’s World Motor Vehicle Data

10-Year Bond Rate and Trade Deficit

10-Year Bond Regression Source: May 2005, Forecast of the Nation

Economic Fallacies & Forecasting Truths



Trade Deficit is a Bad Thing -

Paper Money Vs. Goods: INFLATE AWAY!

-New Gold Brick of the World is the Dollar Export-Led Growth Strategy of East Asia & China is the New Player on the World Stage -Deficits Matter for Long Term Growth But We are All Dead in the Long Run!

DIAMOND OF MONEY

REAL ESTATE COMMERCIAL REAL ESTATE INTEREST RATES TRADE DEFICIT JOB GROWTH CONFIDENCE OIL EURO

But What About the value of the Dollar?

The Meryl Witmer View

“If the dollar is low enough, the world can get its plastic surgery here.”

- Meryl Witmer General partner Eagle Capital Partners, N.Y.

Source: Barron’s, January 19, 2004

China: Threat or Opportunity?

China’s Manufacturing Wage Competitiveness

Japan United States Europe Singapore Korea Taiwan Mexico Brazil China (Manufacturing wages, $ per hour, 2001)

United States: $16.14

China: $0.61

0 2 4 6 8 10 12 14 16 18 Sources: U.S. Bureau of Labor Statistics, China’s National Bureau of Statistics Source: Global Insight World Industry Service

6 4 2 0 14 12 10 8

What is Role of Chinese Exports in World Trade?

Greater China Manufacturing Exports

(Percent share of total world manufacturing exports) 1980 China* 1990 Hong Kong* 1995 Taiwan* 2000 Intra-Regional 2005 * Export totals from China, Hong Kong and Taiwan exclude trade with each other. These are included in Intra-Regional.

Source: Global Insight World Industry Service

Education, Science, and Technology in China

China U.S. Literacy Rate High School Graduates (aged 25+) College Graduates (aged 25+) University Students (per 1,000 people) Personal Computers (per 1,000 people) Scientific & Technical Journal Articles Secure Internet Servers

86% 18% 5% 5.6 19 11,675 184 97% 84% 26% 54.1 625 163,526 78,126

Internet Users (per 1,000 people)

26 501 Source: Federal Reserve Bank of Dallas,

Southwest Economy

, Sept./Oct. 2003

China’s Three Serious Structural Problems

State Sector Inefficiencies (Share in) 1995 Urban Emp: 57% 1995 Production: 34% Banking Fragility (NPL--% of Total Loans) Official: 25% Unofficial: 50%+ (or higher?)

Source: Global Insight World Industry Service

Fiscal Weakness (Gov. Rev.--% GDP) 1985: 21% 1995: 11%

What’s Happening to China’s GDP Statistics?

Source: Thomas Rawski, University of Pittsburgh Paper 2001

What’s Happening to China’s GDP Statistics?

Source: Thomas Rawski, University of Pittsburgh Paper 2001

China Net-Net

  Manufacturing Advantage to China Unless We Stop Shopping at Walmart, Which is Similar to Bleeding the Vein to Cure a Fever!

Technology Advantage to US Unless Our CEO’s/Marketing People Mortgage the Future For a Song by Selling Technology Rights

Anonymous Ventor

My girlfriend demanded that I take her to someplace expensive, so I took her to a gas station Source: AJC, April 21 st , 2005

A Snapshot of the

US

Oil Market in 2001 Consumption (Mbd) 19.63

Production (Mbd) 7.72

Imports (Mbd) 11.62

Source Country Saudi Arabia Venezuela Nigeria Iraq Algeria Imports (Mbd) 1.66

(14.3%)*

1.54

(13.2%)*

0.88

(7.6%)*

0.80

(6.8%)*

0.28

(2.3%)*

Production (Mbd) 8.77

(11.8%)**

3.42

(4.9%)**

2.15

(2.9%)**

2.41

(3.3%)**

1.56

(1.8%)**

*= % of US imports, **= % of world production Source: 2001 BP Statistical Review of World Energy, US Energy Information Agency

Can We Blame China for High Oil Prices?

US Canada Mexico Japan UK China India Russia Middle East Africa VIN* 2000 Production (P) 2004 7.73

2.72

3.45

NA 2.67

3.25

0.78

6.54

23.38

7.86

8.13

7.24

3.09

3.82

NA 2.03

3.49

0.82

9.29

24.57

9.26

7.29

* VIN – Venezuela, Indonesia, Norway

D

P -0.49

0.36

0.37

NA -0.64

0.24

0.04

2.75

1.19

1.41

-0.84

2000 Consumption (C) 2004 19.70

1.94

1.88

20.52

2.21

1.90

5.58

1.70

4.99

5.29

1.76

6.68

2.25

2.47

4.60

2.46

1.75

2.56

2.57

5.29

2.65

1.94

D

C 0.82

0.27

0.01

-0.29

0.05

1.70

0.30

0.10

0.69

0.19

0.19

NET Change in Supply

(D

P –

D

C) -1.31

0.10

0.36

0.29

-0.69

-1.46

-0.26

2.65

0.51

1.22

-1.03

Source: BP Statistical Review of World Energy, June 2005

1.

Improve fuel economy  2.

Ramp up spending on alternative  fuels 3.

Redouble commitment to efficiency ~ 4.

Get serious about solar and wind Yeah, yeah… 5… Source: Fortune, August 23, 2004

History of Energy

Coal Displaced Wood in 19 th Century Oil Displaced Coal in 20 th Century ?

Displaced Oil in 21 th Century