February 10, 2006 (Trade Byte)

Trade Byte

Trade Deficit Hits 4th Consecutive Record

February 10, 2006
By Dean Baker
The trade deficit, measured as a share of GDP, soared to yet another record in 2005, reaching 5.8 percent of GDP, or $725.8 billion. This is the fourth consecutive record deficit and the 5th record in the last six years. Before the recent run-up in deficits, which began in 1998, the prior peak was just 3.1 percent of GDP in 1987.

The 2005 deficit was $108.2 billion higher than in 2004. This increase was driven by another sharp rise in imports. Although the 12.6 percent growth rate in 2005 was slower than the 16.2 percent growth rate in 2004. Increased oil imports accounted for 31.9 percent of the higher import bill, growing from $180.5 billion in 2004 to $252.9 billion in 2005. However, imports rose rapidly in most categories. Imports of capital goods rose by 10.5 percent, imports of consumer goods rose by 9.1 percent, and imports of services rose by 8.3 percent.

Exports grew by 10.7 percent, down from the 12.3 percent growth rate in 2004. The most rapid growth was in exports of industrial supplies, which increased by 13.6 percent in 2005. However, this rise was mostly due to higher prices for exported oil and petroleum products. In real terms, the sharpest growth was in exports of consumer goods, which rose by 10.4 percent, although the 8.5 percent rise in capital goods exports and the 6.0 percent rise in service exports had a larger effect on the trade balance, since the latter two categories are roughly three times as large as exports of consumer goods.

The deficit was increasing over the course of the year (the deficit in the 4th quarter was $793.1 billion at an annual rate, or 6.2 percent of GDP). This means that the trade deficit is likely to set yet another record in 2006, unless there is a sharp downturn in the economy or a plunge in the dollar.

The deficits increased with most countries and regions, which is not surprising given the sharp rise in overall deficit. The biggest increase was with China, with the deficit rising by $39.7 billion to $201.6 billion. The deficit with Japan edged up by $7.1 billion to $82.7 billion. The deficits with the European Union and Canada also rose (by $13.1 billion and $10.0 billion, respectively) indicating that U.S. industry continues to have difficulty competing with other wealthy countries.

At the moment, the trade deficit is being sustained by the decision of foreign central banks (primarily the central banks of China and Japan) to buy up hundreds of billions of dollars each year. This is a conscious decision that they are making primarily to preserve their export market in the United States. It is not clear how much longer these central banks will view the U.S. market as necessary (according to the standard economic theory preached by economists in the United States, shortfalls in demand are not even supposed to exist as a problem), with internal demand in Japan now rising and China's government's concerns about an overheated economy.

The eventual correction will likely prove to be very painful for the United States. The trade deficit is currently more than twice the size of the unified budget deficit, and in the 4th quarter of 2005 it was $300 billion larger than even the on-budget deficit (which includes the money borrowed from Social Security). Eventually, the trade deficit will have to come close to balance. This would have an impact on living standards that is comparable to an increase in the annual tax burden of $800 billion.

While a trade deficit helps to contain inflation and allows the country to enjoy a higher standard of living in the short-term, it is very similar to borrowing money on a credit card to pay monthly bills. It is difficult to know when the limits of credit will be reached, but it is inevitable that at some point that credit will be restricted if the debt grows too much. This situation describes both the trade deficit and the budget deficit, but the problem is much larger with the trade deficit.

Dean Baker is Co-Director of the Center for Economic and Policy Research in Washington, D.C.

CEPR’s Trade Byte is published every year upon release of the Commerce Department's' report on U.S. international trade.