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America's terrible trade deficit is slowing our recovery

 

Friday, the Commerce Department is expected to report that the deficit on international trade in goods and services was $46 billion in December, a bit lower than November owing to slower inventory build among U.S. wholesalers and retailers and moderating oil prices.

Overall, the deficit is a significant tax on aggregate demand just as a government deficit increases demand for U.S. made products. In the coming months if oil prices climb higher, and if the economy manages to dodge a recession, if there is a stronger inventory build and moderate retail sales growth, it will push up the trade deficit again and slow economic recovery.

Persistently high trade deficits and continuing low real estate values are the most significant reasons why the current economic recovery is slowest since the Great Depression. It's also why  Congress and the resident face so much difficulty stabilizing federal finances without risking thrusting the economy in to recession.

Persistently high trade deficits and continuing low real estate values are the most significant reasons why the current economic recovery is slowest since the Great Depression

Consumer spending continues to expand, though haltingly, and the annual federal deficit increased from $161 billion before the financial crisis to more than $1 trillion over the last five years, injecting enormous additional demand into the system. However, too many consumer dollars go abroad for Middle East oil and Chinese goods that do not return to buy U.S. exports, and higher oil prices will up the trade gap in 2013

Businesses, consequently, are pessimistic about future demand for U.S.-made goods and services, and bearing higher corporate and other business taxes than foreign competitors, rising employee benefit costs mandated by Obama are and more cumbersome business regulations are reluctant to hire in the United States.

Although rising wages in China are making U.S. locations somewhat more attractive than in recent years, cumbersome business regulations add costs and slow, and even stifle, Greenfield investments and expansion of existing facilities.

Those barriers frustrated the virtuous cycle of temporary tax cuts and additional government spending, new hiring, and additional household spending the first-term Obama stimulus sought to beget.

Now the Fiscal Cliff deal will raise combined federal and state tax rates for many small businesses on expansion and reinvestment to maintain existing facilities to more than fifty percent—in California and New York even more. Look for multinational corporations to shift sourcing and jobs from many U.S. small enterprises to Asia.

Prior to the Fiscal Cliff tax increases, economists predicted growth of about 2 percent for 2013. However, these new taxes on small business investment and innovation strike at the heart of this once vibrant American jobs creating machine—look for growth in the range of 1.5 percent and a tougher jobs market through mid-year.

Growth below 2 percent is difficult to sustain—any disruption could set off a cycle of layoffs, falling consumer spending and ultimately a recession that pushes unemployment into double digits.

Should tax increases be necessary to reach a political compromise to further reduce the budget deficit, Congress should heed President Obama’s recommendation that tax loop holes like the carried interest provision—which permits Wall Street traders and executives throughout the economy to pay lower tax rates than ordinary wage earns—should be heeded. That would do the least damage to aggregate demand, and actually improve economic incentives to stimulate growth.

Imported oil and subsidized imports from China account for the entire trade gap.

Development of new onshore reserves in the Lower 48 has not delivered enough new oil, and a full push on U.S. reserves in the Gulf, off the Atlantic and Pacific coasts and in Alaska could cut U.S. imports in half. Shifting federal subsidies from cost ineffective electric cars, wind and solar to more fuel efficient internal combustion engines and plug-in hybrids could further cut U.S. petroleum imports.

To keep Chinese products artificially inexpensive on U.S. store shelves, Beijing undervalues the yuan through official intervention in currency markets and actions of state owned banks, which often evade calibration in their scope. China extorts U.S. firms to transfer manufacturing technology, subsidizes exports and imposes high tariffs on imports. Other Asia governments, most recently Japan, have adopted similar exchange policies to stay competitive with the Middle Kingdom.

Economists across the ideological and political spectrum have offered strategies to offset the deleterious consequences of currency strategies on the U.S. economy and force China and others to abandon mercantilist policies. However, China offers token gestures, and sadly the Treasury accepts these instead of even acknowledging Beijing’s cynical strategy.

Cutting the trade deficit by $300 billion, through domestic energy development and conservation, and forcing China’s hand on protectionism would increase GDP by about $500 billion a year and create at least 5 million jobs.

Longer term, large trade deficits shift resources from manufacturing and service activities that compete in global markets to domestically focused industries. The former undertake much more R&D and investments in human capital.

Cutting the trade deficit in half would raise long-term U.S. economic growth by one to two percentage points a year. But for the trade deficits of the Bush and Obama years, U.S. GDP would be 10 to 20 percent greater than it is today, and unemployment and budget deficits not much of a problem.

Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist. He is the five time winner of the MarketWatch best forecaster award. Follow him on Twitter @PMorici1.