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Why the Trade Deficit Matters So Much

The Commerce Department Thursday plans to report the January deficit in international trade in goods and services. Analysts expect it to increase to $41 billion from $40.2 billion in December. My forecast for January is $41.5 billion

The trade deficit, along with the credit and housing bubbles, were the principal causes of the Great Recession. Now, a rising trade deficit and continued weakness among regional banks threatens to stifle the emerging recovery and keep unemployment near 10% through 2011.

At 3.1% of GDP, the trade deficit subtracts more from the demand for U.S.-made goods and services than President Obama's stimulus package adds. Moreover, Obama's stimulus is temporary, whereas the trade deficit is permanent and growing.

Subsidized manufactures from China and petroleum account for nearly the entire deficit, and both will rise as consumer spending and oil prices rise through 2010.

Money spent on Chinese coffee makers and Middle East oil cannot be spent on U.S.-made goods and services, unless offset by exports.

When imports substantially exceed exports, Americans must consume much more than what they earn producing goods and services, or the demand for what they make is inadequate to clear the shelves, inventories pile up, layoffs result, and the economy goes into recession.

From 2004 to 2008, the trade deficit exceeded 5% of GDP, and Americans borrowed from abroad to keep the economy going. To consume more than they produced, they posted as collateral overvalued homes financed on shaky mortgages. When mortgages and banks failed, home prices and retail sales tanked, the shortfall in demand for U.S. made goods and services drove up unemployment, further choked consumer and investment spending, and thrust the economy into the worst recession in 70 years.

Now huge federal stimulus spending is required to resuscitate business activity. However, as the economy recovers, the trade deficit on oil and with China will grow, taxing demand for U.S. goods and services. Once that money is spent, demand for American products will fall, and the economy will be at risk of a second recession.

President Obama ignores the fundamental causes of trade deficit; consequently, his policies to fight the recession will deliver only a moderate recovery in 2010. Imports of oil and Chinese consumer goods will rise as the economy recovers. As stimulus spending runs out, the escalating trade deficit will push the economy down again and threaten a second recession -- the feared "W"-shaped recovery.

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