"Frack and Slack" Put U.S. Trade in the Black?
By Milton Ezrati
December 21, 2012
Could it be that the U.S. trade balance is headed into the black? At first blush, the prospect looks dubious. This country's trade deficit has drifted deeper into the red for so many decades now that few can even conceive of lasting improvement. Even so, that is what seems to be in prospect. The gap between what this country buys from the world and what is sold to it has already narrowed considerably, and shows every indication of continuing to do so because of currency shifts and, more fundamentally, because of alterations in China's and Japan's economies and from the remarkable turn in the mix of global energy production.
The old, depressing trade patterns had persisted for so long that they seemed immutable. They remain an underlying assumption in just about all economic, financial, and currency analyses. And such a default to deficit is understandable. The country's trade position had deteriorated, almost uninterrupted, for better than 60 years. In 1947, according to the Department of Commerce,1 the United States sold the world $10.1 billion more in manufacturers, minerals, and other physical products than it imported—a surplus of more than 4% of that year's gross domestic product (GDP). By 1960, the positive gap had shrunk to $5.3 billion, a mere 1.0% of that year's GDP. The balance slipped firmly into the red in 1974. By 1984, the deficit had widened to almost $111 billion, 2.8% of GDP, and by 1994, it averaged almost $685 billion, fully 5.8% of GDP. By 2006, it stood at $860 billion, a whopping 6.4% of GDP. It was not a pretty or an encouraging picture.
But since, this otherwise well-established trend has begun to turn. By the end of 2009, for example, the deficit between goods exports and imports had shrunk to $586 billion, a much more manageable 4.1% of GDP. The gap widened slightly in 2011, reapproaching 5.0% of GDP, but then began to shrink again. This year’s third quarter (the latest period for which such data exist) saw the gap narrow back down to 4.5% of GDP. Monthly data through October (the latest month for which statistics are available) show goods exports up almost 5.0% so far this year, while imports have risen only 3.4%. The trade imbalance, accordingly, has shrunk by more than $6 billion, or at more than a 20% annualized rate since last December.
After this long history of deterioration, there is a strong temptation to write off any improvement as temporary. That impulse, understandable as it is, would, however, be misplaced, for the recent improvement comes with much evidence to suggest that the change is fundamental and durable. Part of the story concerns the dollar. Its exchange value has dropped precipitously over the long haul, making U.S.-made goods cheaper on global markets than they have been in decades, at least compared with the competition. Over the last 12 years, the dollar has fallen more than 50% against the euro, even after incorporating recent dollar gains in response to the eurozone's sovereign debt crises. The greenback has fallen only 3.1% against the pound sterling, but a game-changing 61% against the Canadian dollar and a still large 25% against the Japanese yen. It has even fallen almost 27% against the China's yuan.
The effect is evident in this country's bilateral trade figures. In 2011, for instance, the United States ran a $63 billion deficit on goods trade with Japan alone. That deficit has shrunk $5.6 billion so far this year or about 9%. Trade with Canada, the United States' largest trading partner, has made an even more dramatic shift, with the bilateral deficit narrowing some $11 billion, or 32%. With Germany, the deficit has narrowed by about $7 billion, or almost 14%. Even with China, the balance has narrowed by 20% from last year, to an admittedly still large deficit of $232.2 billion.
Contributing still more fundamentally to this turn are domestic policy changes in China and Japan. Japan's population has already aged to the point where one in five is above retirement age. Though Japanese business has adjusted some to the circumstance, the aged population simply makes it impossible for that country to continue its former role as the workshop of the world. Meanwhile China, which does not yet have Japan's demographic problems, has begun to reorient its development policy away from its former, almost exclusive emphasis on exports. Though the country remains a fierce global competitor, particularly when it comes to cheaper consumer goods, the new, additional focus on domestic development will continue to open China's door wider to imports, particularly of American-made equipment. Since Japan and China constitute more than half of the total U.S. trade deficit, those changes have contributed, no doubt significantly, to the favorable turn in trade, and will likely continue to do so.
Still more a factor in creating this turn is the so-called fracking revolution in hydrocarbon extraction. It promises to increase global production of fossil fuels so markedly that falling oil and gas prices will cut the expense for this major U.S. import. But fracking, by increasing domestic American hydrocarbon supplies, also will eliminate this country's need to import the volumes it has in the past. The introduction of this technique has already reduced U.S. fuel oil imports almost 5% from the comparable period in 2011. It has cut crude oil imports by 2.4%. With natural gas, where fracking has had its biggest effect, imports have dropped by almost 40%. Meanwhile, petroleum exports have risen almost 11%. The overall trade deficit in fossil fuels, fully 40% of the entire U.S. trade deficit, has improved by more than 8.0%. What is more, the effect should build going forward as the economy takes fuller advantage of its new fuel supplies, particularly of natural gas. In time, the United States should become a net exporter of liquefied natural gas and perhaps oil.
Even if this new turn can carry on uninterruptedly, it would still take a long while to erase the trade deficit, presently still more than $550 billion a year in deficit. An extension of this year's rate improvement would still take until almost 2020 just to approach balance. Since this country runs a chronic and growing surplus on services, the combined balance on goods and services might approach balance a little sooner, but there are also bound to be interruptions. Either way, it is too early and too tenuous to start looking for a surplus anytime soon.
Still, long before a surplus emerges, the easing deficit pressure could reduce the net flow of dollars out of this country. That development should lift a chronic weight off the dollar's foreign exchange value and also remove a destabilizing influence from global financial markets. Trade, of course, is far from the only influence on currency or international funds flows. Washington's other big deficit, its budget, could erode confidence in the dollar enough to overwhelm any favorable effects from an improving balance of payments. But if prospects for the currency and financial markets remain ambiguous, the favorable growth implications of the fracking revolution, and its promise of cheaper, more plentiful, and more reliable fuel, are clear. As a spur to growth, fracking could do more to relieve financial and fiscal problems than any improvement in the overall trade situation. It could, in fact, erase decades-old concerns. If it is too soon to embrace such optimism, it is pleasant, especially in this season of hope, to contemplate the possibility.
I would like to thank Michael Weldon, Lord Abbett Partner and Director of Marketing, for suggesting this line of analysis.
1 All data in the article are from the U.S. Department of Commerce.
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